1. Capital Structure and Leverage
Capital structure and financial structure
Capital structure determines a firm’s fiscal and organizational health. Financial executives create optimal
capital structure by diversifying company debts and equity. Optimal capital structure is the key to decreasing
expenses and increasing profits for stakeholders. Capital structure is the composition of long term sources of
capital. Long term debt and equity capital are the long term sources of capital. In other words, capital structure
is the composition of long term sources of financing.
Equity capital is owners’ money and consists of common stock, paid in capital and retained earnings. Debt is
borrowed money and can be classified as short term debt and long term debt. Financial structure is the
composition of short term debt, long term debt, preferred stock and equity. So, financial structure consists of
liabilities side of balance sheet of a firm.
 Optimal capital structure is the mix of debt and equity that results to minimum weighted cost of
capital.
 Business Risk is the variation in the return due to the inherent attributes of operation of a firm. This is
also called as operating risk.
 Financial Risk is the additional risk above business risk imposed on firms’ common stockholders
because of the use of debt capital.
Break-Even Analysis
 Break-Even Point is the level of production and sales at which total revenue is equal to total operating
costs. This is also known as operating break-even point
.
Operating BEP (in unit) =
𝑭𝒄
𝑺−𝑽
Operating BEP (in Rs) =
𝑭𝒄
𝑷𝑽 𝑹𝒂𝒕𝒊𝒐
Where PV Ratio =
𝑆−𝑉
𝑆

2.  Cash Break-Even Point is that types of break-even point where it is calculated using only cash fixed
operating cost. Cash break-even point is always less than operating BEP because it excludes non cash
fixed operating costs.
Cash BEP(in unit) =
𝑭𝒄−𝑫𝒆𝒑
𝑺−𝑽
 Financial Break-Even Point is the amount of EBIT at which a firm’s EPS is zero.
Financial BEP = 𝑰 +
𝑷𝑫
𝟏−𝑻
 Operating leverage refers to the potential use of fixed operating costs. It is the responsiveness of
change in operating profit to the change in sales.
Contribution Margin (PV) ratio = (S-V)/S
Cash BEP= (FC-Dep)/S-V
The DOL 2 times implies that if sales increases by 10% the EBIT will increase by 5 times of it or
by 50%
 Financial leverage: Financial leverage is the responsiveness of change in firm’s EPS to the
change in EBIT. Financial leverage is mainly related to the mix of debt and equity in the capital
structure of a firm. It exists due to the existence of fixed financial charges that do not depend on
the operating profits of the firm. Debentures, bonds, long-term loans and preference shares are
included in the first category and equity shares are included in the second category. DFL can be
calculate by using following different formulas:

3. If the preferences share capital is given in the problem the degree of financial leverage shall be
computed by using the following formula
 Combined Leverage: It is also known as total leverage. It is the combination of operating and financial
leverage thatmeasure the responsivenessof change inEPSto the change insales.
Factors Affecting Capital structure Decision.
 Size of Firm Business Risk
 Growth in sales Financial Flexibility
 Management style ` Growth rate