2. Meaning & Definition
of Capital Structure
• Capital Structure is, ”the permanent
financing of the firm represented by long-
term debt, preferred stock and networth”
-Weston & Brigham
Page 2
3. Debt
• Any source that gives the funding agency the
creditorship status
• In the horizontal form of Corporate Balance Sheet,
it is the sum of III and IV items(Secured Loans and
Unsecured Loans) on the Liabilities side of the
Balance Sheet
• In the vertical format, it is the II item (which again
contains Secured Loans and Unsecured Loans) on
the side of Sources of Funds Page 3
4. Features of Debt
• Compulsory Payment of Interest
• Compulsory Repayment
• Only Fixed Interest
• No Annual Reports
• No Voting Rights
Page 4
5. Merits of Debt
• Benefit of Leverage • Manageable
• Cost of Raising Funds Administrative
• Tax Advantage Expenses
• Managerial Stability • Flexible Repayment
• Easier SEBI Norms • Easier Regulatory
Compliance
• Flexible Features
• Stable Market for
Securities
Page 5
6. Demerits of Debt
• Compulsory Payment of Interest
• Solvency Affected
• Compulsory Redemption
• Charge on Assets
• Credit Rate Shopping
Page 6
7. Equity
• Shareholders Fund or Ownership Capital
• Compulsory Component of the Capital Structure
• Sum of Equity Share Capital, Preference Share Capital and
Reserves and Surplus
• Preference Shares are not a Popular Instrument
Page 7
8. Equity Shares
• Common Stock/Ordinary Shares
• Full Fledged Ownership
• Total Entitlement to the Assets
• Repayment After the Satisfaction of Every
Other Claim
• Preemptive Right
• Entitlement for Dividend, Bonus Shares
and Other Such Rewards
Page 8
9. Benefits of Equity Shares
• Basic for Capital • Evaluation of Share
Structure Value
• Better Solvency • Better Image
• Gestation Period • Creation of Value
• No Redemption • Public Knowledge of
• No Charge on Assets Financial Information
• No Shopping for
Credit Rating
Page 9
10. Demerits of Equity Shares
• Tax Implication • High Volatility in the
• Management Control Stock Market
• High Rates of • Speculation
Dividend • Complex
• Lack of Flexibility Shareholder-
• Stringent SEBI Norms Management Relation
• Huge Issue Expenses • Rigid Corporate
Governance
Page 10
11. DE RATIO=LONG TERM DEBT:
NETWORTH
Long TermDebt
DE MIX=
Networth
Page 11
14. Calculate Debt Equity Ratio of Precision Limited whose Balance Sheet
as on March 31, 2004 was as given below
Amount Amount
Liabilities (Rs) Assets (Rs)
Equity Shares 4,00,000 Fixed Assets 26,00,000
12% Preference Shares 2,00,000
General Reserve 50,000 Current Assets,
Profit & Loss A/c 50,000 Loans & Advances 6,00,000
15% Mortgage Debt 15,50,000
Loan from IDBI 5,50,000
Current Liabilities &
Provisions 4,00,000
Total 32,00,000 Total 32,00,000
Page 14
15. Bentley Systems Limited had the following Balance Sheet
as on 31-3-2004. Calculate Debt Equity Ratio.
Amount Amount
Liabilities Assets
(Rs) (Rs)
I SHARE CAPITAL; I FIXED ASSETS 16,00,000
Equity Shares 3,00,000 II INVESTMENTS ---
Pref.Shares 1,00,000 III CURRENT ASSETS,
II RESERVES & LOANS & ADVANCES 2,00,000
SURPLUS 2,50,000 IV MISCELLANEOUS
III SECURED LOANS 10,00,000 EXPENDITURE:
IV UNSECURED Preliminary Exps 40,000
LOANS 2,00,000 Disc.on Issue of
V CURRENT Shares 30,000
LIABILITIES 50,000 Profit & Loss A/c 30,000
& PROVISIONS
19,00,000 19,00,000
Page 15
16. 2.3 Calculate Debt Equity Ratio of Suryodaya Chemicals 2000-01.
Comment on the variation in the debt equity ratio from the year 2000 to
the year 2001.
Liabilities 2000 2001 Assets 2000 2001
Sundry Creditors 78,300 89,900 Cash 19,400 17,600
Bills Payable 61,700 30,100 S.Debtors 2,80,600 2,62,400
15% Debentures 9,00,000 6,00,000 S.Advance 75,000 60,000
LT Loans 6,00,000 8,00,000 Stock 3,48,000 3,70,000
Reserves 80,200 1,17,500 Land & Bld 4,07,000 5,30,000
Profit & Loss A/c 1,19,800 1,82,500 Plant & Ma. 8,20,000 7.90.000
Equity Share Cap 3,00,000 4,00,000 Goodwill 1,90,000 1,90,000
21,40,000 22,20,000 21,40,000 22,20,000
Page 16
17. Solution for Suryodaya Chemicals
2.3
• For 2000: Long Term Debt = Deb + LT
Loans
= 9,00,000 + 6,00,000= 15,00,000
• Equity = Eq.Shares + P&L A/c + Reserves
= 3,00,000 + 1,19,800 + 80,200
= 5,00,000
• Debt Equity Ratio = 15,00,000 : 5,00,000
= 3:1
Page 17
18. DE Ratio for 2001
• LT Debt = 6,00,000 + 8,00,000 = 14,00,000
• Equity = 4,00,000 + 1,82,500 + 1,17,500
= 7,00,000
DE Ratio = 14,00,000 : 7,00,000 = 2:1
DE Ratio has come down due to lesser
component of Debentures even though LT
Loan has gone up. Every component of
equity has also gone up.
Page 18
19. Debt Equity Mix
• Significance of a High Debt Equity Mix: Reduced
Tax Liability, Higher EPS
• Significance of a Low Debt Equity Mix: Better Risk
Management
• Zero Debt Capital Structure and Its Relevance
-Reducing Corporate Tax Rates
-Equity Tied Image
-Opportunity for Mergers & Acquisitions
-Other Benefits
Trading on Equity
Page 19
20. Preparation of Statement of Income
• Leverages: Operating Leverage, Financial
Leverage and Combined Leverage
• Degree of Leverages
• Significance of Each Leverage:
-Sales-EBIT-EPS Relation
-Measurement of Risk Levels
-Behaviour of Costs
Page 20
21. Operating Leverage
• The presence of fixed cost in the cost
structure leads to operating leverage
• A certain percentage of increase in sales
results in increases percentage of
increase in EBIT
• Operating Leverage is a measure that
determines the number of times the EBIT
goes up due to a given increase in the
sales
Page 21
22. Significance of Operating Leverage
• Sales-Operating Profit Relation
• Role of Fixed Cost
• Measurement of Operating Risk
Page 22
23. Quantitative Significance of
Operating Leverage
• A Company had an operating leverage of
3. If sales goes up by 20%, calculate the
percentage of increase in EBIT.
Page 23
24. Calculate the operating leverage
from the following details:
Sales 3,750 units; Variable Cost Rs.14
per unit; Price per unit Rs.16 and Fixed
Cost –Rs.4,000.
With the help of operating leverage,
calculate the percentage of increase in
EBIT for an increase of 10% in sales
Page 24
25. Hercules Products Limited presents
the following details. You are
required to calculate the operating
leverage. Selling price per unit-
Rs.10; Sales-3 lakh units; variable
cost-Rs.6 per unit and fixed cost-
Rs.6,00,000. Analyse the situation
with an output of 4 lakh units
Page 25
26. Financial Leverage
• Financial leverage is the magnified impact
produced on the EPS of a company for a
given increase in the operating profit or
EBIT.
• If a company has an operating leverage of
3, a 20% increase in EBIT will result in a
60% increase in the EPS
Page 26
27. Measurement of Financial Leverage
• Where there is no Preference Share
EBIT
Financial Leverage= ---------
EBT
• Where there is preference share,
EBIT
FinancialL everage
P
EBT
1 T
Page 27
28. Statement of Income
Amount
Rs.
• Sales.... --------
(-) Variable Cost.. --------
Contribution --------
(-) Fixed Cost --------
Operating Profit/ (EBIT) -------
(-) Interest -------
(EBT)
(-) Tax -------
Earning After Tax (EAT) ----
• (-) Preference Dividend ----
Surplus Profit ----
• Surplus Profit
• Earning Per Shares (EPS) =-----------------------
No of Equity Shares
Page 28
29. Significance of Financial Leverage
• Tool for Investment
• Relation between EBIT and EPS (A Financial
Leverage of 3 means a 10% increase in EBIT
will result in 30% increase in EPS)
• Measurement of Financial Risk
Page 29
30. Combined Leverage
• Measures the impact on EPS for a given
percentage of increase in Sales
• Combined Leverage = OL X FL
Contributi on
• Combined Leverage =
EBT
Page 30
31. Significance of Combined Leverage
• Total Risk Level of the Organisaion
• Measures the Relation between Sales and EPS
(A Combined Leverage of 5 means a 10%
increase in Sales will result in 50% increase in
the EPS)
Page 31
