1. 1. Student of BMU Rohtak By :-NEERAJ SINDHU B.tech, MBA (Finance & Marketing) Capital Structure
2. 2. BY THE END OF THIS SESSION WE WOULD BE ABLE TO LEARN Capital Structure Features of Capital Structure Factors affecting capital structure Merits and Demerits
3. 3. Meaning of Capital Structure The mix of the different sources of long term funds in the total capital of the company Equity Preference shares Debentures Retained earning
4. 4. Capital can be raised by 2 means 1. Ownership securities . Equity Shares . Preference Shares 2. Creditor ship Securities - Debentures/Bonds
5. 5. Features of Capital Structure Return Minimum Risk Simplicity Flexibility Capacity Control
6. 6. Features of Capital Structure Return Management is to provide the maximum earnings to the equity shareholders. It can be obtained by minimising the cost of issue and the cost of financing. Minimum Risk- It should involve minimum possible risk of loss of control. Thus, it, should be least risk.
7. 7. Simplicity As far as possible capital structure must be simple. It is easy to manage it. Thus it should be convenient. Flexibility The capital structure should be flexible. It should be possible for a company to adapt its capital structure with a minimum cost.
8. 8. Capacity The capital structure should be determined within the debt capacity of the company, and this capacity should not be exceeded. The debt capacity of a company depends on its ability to generate future cash flow. Control The capital structure should involve minimum risk of loss of control of the company.
9. 9. Factors Affecting Capital Structure Trading on equity Govt. Policy Retaining Control Provision for the feature Nature of Enterprise Legal Requirements Purpose of financing Period of finance Requirements of investors Size of company
10. 10. Factors Affecting Capital Structure Trading on equity In case the rate of return on the capital Employed is more than the rate of interest on debentures or rate of dividend on preference shares, it is said that the company is on trading on equity. Govt. Policy The monetary and fiscal policies of the govt. also affect the capital structure decision.
11. 11. Contd Retaining Control The preference shareholders and debenture holders have not much say in the management of the company. It is the equity shareholders who select the team of managerial personnel. Provision for the Future While planning capital structure the provision for future should also be kept in view.
12. 12. Contd Nature of Enterprise - Business enterprises which have stability in their earning or which enjoy monopoly regarding their products may go for debenture or preference shares since they will have adequate profits to meet the recurring cost of intrest. Legal Requirement The govt. has issued certain guideline for the issue of share and debentures. The restrictions are very significant.
13. 13. Contd Purpose of financing The purpose of financing also to same extent after the capital structure of the company. In case funds are required for some directly productive purposes. Ex. Purchase of new machinery, the company can afford to rise the funds by issue of debenture . On the other hand funds are required for non-productive purpose.
14. 14. Contd Period of finance The period which finance is required also effect the determination of capital structure of companies. In case funds are required, say for 3 or 10 years, it will appropriate to rise them by issue of debenture rather then by issue of shares. However if the funds are required are more or less permanently, it will be appropriate to ruse them by issue of equity share.
15. 15. Requirements of investors Different types of securities are to be issued for different classes of investors. Equity share are best suited for investors who are very cautious while preference share are suitable for investors who are not very cautious.
16. 16. Size of company - Companies which are of small size have to really upon the owners funds for financing. Large companiesare considered to be less
17. 17. When company has only Equity shares Merits: No fixed liability Equity share do not create any fixed liability in respect of payment of dividend. No charge on assets Equity shares do not create any charge or mortgage on the assets or property of the company. Therefore, in times of need the company can use its assets to rise loans.
18. 18. Contd No liability to redeem Capital raised through equity shares does not have to be repaid until the company itself is would up, this would be long-range planning in respect of the company. Voting control right Equity shares entitle the owner to control and manage the company. Equity shares are greatly preferred by bold and risk-loving investors. Because owners of equity share are real owner of a company.
19. 19. Contd Trading on the equity The company runs on risk of magnifying losses in bad periods through trading on the equity. Easy and economical To obtain capital by the issue of equity share is economical. It can be very easily procured. Without creating any charge on the property of the company.
20. 20. Demerits Signal of capitalisation If promoter miscalculates in working out financial requirement of a company. The company may land in a situation where it has a large surplus of capital. High cost of fund raising As many bold and risk loving investors is always small. The company has to spend much time and money to rise equity capital.
21. 21. Contd Absence of close control: In a company which is financed largely by equity shares. The number of equity shareholders will be quite large. As such it would become difficult to have effective management and control of its affairs due to wide diffusion of ownership. No Investment by Cautious Investors: Cautious and risk bearing investors keep away from equity shares because of uncertainty of return and fear about safety of capital. Thus the company is denied the opportunity to raise funds from such investors whose number is admittedly quite large.
22. 22. When a company has both equity and preference shares: Merits: 1. Wider coverage: The company with both equity and preference shares will appeal to a wider variety of investors. Those of the investors who love to take risk and desire to manage as well as control the company, can opt for equity shares. 2. Elastic capital structure: The capital structure of the company can be made more elastic and more economical.
23. 23. Contd 3. Closer control: Preference shares generally do not carry any voting rights. Thus equity shareholders can manage and control the company without interference from any quarter. 4. Over capitalisation remedied: The company may take remedial step for over capitalisation by the redeemption of redeemable preference shares.
24. 24. Demerits 1. Dilution of trading on equity: The company with both equity and preference shares can trade on the equity, but not to any significant extent. 2. Absence of close control: In case the company makes any default in paying dividend to preference shareholder, they will earn the right to attend the general meeting and to vote on matters affecting their interests.