Capital  Structure
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Capital Structure

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    Capital  Structure Capital Structure Presentation Transcript

      • 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
    • 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.
    • 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.
    • 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.
    • 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.
    • 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.
    • 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
    • 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.
    • 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.
    • 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.
      • Thank You