1. Student of BMU Rohtak By :-NEERAJ SINDHU B.tech, MBA
(Finance & Marketing) Capital Structure
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. 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. Capital can be raised by 2 means 1. Ownership securities .
Equity Shares . Preference Shares 2. Creditor ship Securities -
Debentures/Bonds
5. Features of Capital Structure Return Minimum Risk Simplicity
Flexibility Capacity Control
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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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.