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Capital Structure
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Capital Structure

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Published in: Economy & Finance, Business
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  • 1.
  • 2.
    • A way a corporation finances itself through some combination of equity and debt.
    • The capital structure should be designed with the aim of maximizing the market valuation of the firm in the long run.
    Capital Structure
  • 3. Determinants of Capital Structure
    • Type of asset financed
    • Ideally short term liabilities should be used to create short term assets and long term liabilities for long term assets.
    • Else an AL mismatch may take place which may introduce an element of risk.
  • 4. Determinants of Capital Structure
    • Nature of the Industry
    • A firm relies more on long term debt and equity if its capital intensity is high.
    • If the business is seasonal in nature, needs at seasonal peaks may be financed by short term debt.
    • Capital structure should be suitably designed keeping the nature of the industry.
  • 5. Determinants of Capital Structure
    • Degree of Competition
    • A business characterized by intense competition and low entry barriers faces greater risk of earnings fluctuations. Equity financing may be more appropriate here.
    • A business characterized by less competition and high entry barriers faces lower risk of earnings fluctuations.
  • 6. Determinants of Capital Structure
    • Obsolescence
    • Key factors that lead to Obsolescence need to be identified.
    • Obsolescence can occur in products, manufacturing processes, materials and even in marketing.
    • If chances of obsolescence are high, capital structure should be built conservatively.
  • 7. Determinants of Capital Structure
    • PLC
    • At the introduction stage, risks are high. Therefore, equity is the primary source of finance. Financial leverage may not be affordable.
    • Growth phase – Risks may decrease but huge investments may be needed which may require doses of debt plus periodic induction of equity.
    • In maturity, leverage is likely to decline as cash flows accelerate.
  • 8. Determinants of Capital Structure
    • Financial Policy
    • Capital structure to be designed keeping in mind the overall financial policy of the firm.
    • The management might have decided on
    • 2.1 Debt : Equity ratio
    • 2.2 Dividend Payout
    • 2.3 Debt Service coverage
  • 9. Determinants of Capital Structure
    • Past and Present Capital Structure
    • Determined by past events.
    • Prior financing, investment, acquisitions, may create conditions which may be difficult to change in the short run.
    • However medium to long term decisions to alter capital structure may be effected by issuing and retiring debt, issuing equity, equity buy backs, altering dividend policies etc.
  • 10. Determinants of Capital Structure
    • Corporate Control
    • Firms vulnerable to takeover are averse to further issuance of equity as it can result in the dilution of the ownership stake.
    • Such firms place more reliance on debt.
    • Firms with strong management (having controlling stake) are unlikely to have reservations over further issue of equity.
  • 11. Determinants of Capital Structure
    • Credit Rating
    • Market assigns a great deal of weightage to the credit rating of a firm. Hence obtaining a good rating has become imperative.
    • Market reacts negatively to any downgrading in the rating.
    • This may result in a denial of access to capital.
  • 12.
    • Thank You

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