Capital structure b.v.raghunandan

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Revised Version of Capital Structure dealing with Debt-Equity Ratio and Leverages

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Capital structure b.v.raghunandan

  1. 1. Capital Structure-B.V.Raghunandan, SVS College,Bantwal Bharathi College, Mangalore September 8, 2012 Page 1
  2. 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. 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. 4. Features of Debt • Compulsory Payment of Interest • Compulsory Repayment • Only Fixed Interest • No Annual Reports • No Voting Rights Page 4
  5. 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. 6. Demerits of Debt• Compulsory Payment of Interest• Solvency Affected• Compulsory Redemption• Charge on Assets• Credit Rate Shopping Page 6
  7. 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. 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. 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. 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. 11. DE RATIO=LONG TERM DEBT:NETWORTH Long TermDebtDE MIX= Networth Page 11
  12. 12. LONG-TERM DEBT=SECUREDLOANS + UNSECURED LOANSLong-Term Debt= Debentures +Bonds + Long Term Loans Page 12
  13. 13. NETWORTH=SHAREHOLDERS’FUNDS Networth = Share Capital + Reserves & Surplus – Fictitious Assets Page 13
  14. 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 26,00,00012% Preference Shares 2,00,000General Reserve 50,000 Current Assets,Profit & Loss A/c 50,000 Loans & Advances 6,00,00015% Mortgage Debt 15,50,000Loan from IDBI 5,50,000Current Liabilities &Provisions 4,00,000 Total 32,00,000 Total 32,00,000 Page 14
  15. 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 2,00,000SURPLUS 2,50,000 IV MISCELLANEOUSIII SECURED LOANS 10,00,000 EXPENDITURE:IV UNSECURED Preliminary Exps 40,000LOANS 2,00,000 Disc.on Issue ofV CURRENT Shares 30,000LIABILITIES 50,000 Profit & Loss A/c 30,000 & PROVISIONS 19,00,000 19,00,000 Page 15
  16. 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 2001Sundry Creditors 78,300 89,900 Cash 19,400 17,600Bills Payable 61,700 30,100 S.Debtors 2,80,600 2,62,40015% Debentures 9,00,000 6,00,000 S.Advance 75,000 60,000LT Loans 6,00,000 8,00,000 Stock 3,48,000 3,70,000Reserves 80,200 1,17,500 Land & Bld 4,07,000 5,30,000Profit & Loss A/c 1,19,800 1,82,500 Plant & Ma. 8,20,000 7.90.000Equity 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. 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. 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 = 7,00,000DE 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. 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 BenefitsTrading on Equity Page 19
  20. 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. 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. 22. Significance of Operating Leverage• Sales-Operating Profit Relation• Role of Fixed Cost• Measurement of Operating Risk Page 22
  23. 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. 24. Calculate the operating leveragefrom the following details:Sales 3,750 units; Variable Cost Rs.14per unit; Price per unit Rs.16 and FixedCost –Rs.4,000.With the help of operating leverage,calculate the percentage of increase inEBIT for an increase of 10% in sales Page 24
  25. 25. Hercules Products Limited presentsthe following details. You arerequired to calculate the operatingleverage. Selling price per unit-Rs.10; Sales-3 lakh units; variablecost-Rs.6 per unit and fixed cost-Rs.6,00,000. Analyse the situationwith an output of 4 lakh units Page 25
  26. 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. 27. Measurement of Financial Leverage• Where there is no Preference Share EBIT Financial Leverage= --------- EBT• Where there is preference share, EBIT FinancialLeverage P EBT 1 T Page 27
  28. 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. 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. 30. Combined Leverage• Measures the impact on EPS for a given percentage of increase in Sales• Combined Leverage = OL X FL Contribution• Combined Leverage = EBT Page 30
  31. 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
  32. 32. THANK YOU Page 32

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