I am student of fjwu . it will be beneficial for students to understand the topic of capital structure.

1. Capital Structure
Equity + Debt

2. Equity
Equity is the value attributable to the owners of business.
There are generally two types of equity:
 Book value(Assets-Liabilities)
 Market values(Share price * No of shares)
Equity is more expensive than debt, especially when
interest rates are low. On the other hand, equity
represents a claim on the future earnings of the company
as a part owner.

3. Debt
Debt financing occurs when a firm raises money
for working capital or capital expenditures by
selling debt instruments to individuals and/or
institutional investors. In return for lending the
money, the individuals or institutions become
creditors and receive a promise that the principal
and interest on the debt will be repaid.
Formula:
KD = Interest Expense x (1 - Tax Rate)

4. Debt
Companies like to issue debt because of the tax
advantages. Interest payments are tax
deductible. Debt also allows a company or
business to retain ownership, unlike equity.
Additionally, in times of low interest rates, debt
is abundant and easy to access.

5. Capital structure
Capital structure can be a mixture of a firm's long-term
debt, short-term debt, common equity and preferred
equity. A company's proportion of short- and long-term
debt is considered when analyzing capital structure.
When analysts refer to capital structure, they are most
likely referring to a firm's debt-to-equity (D/E) ratio,
which provides insight into how risky a company is.

6. Importance of Capital
Structure:
 Value Maximization
 Cost Minimization
 Investment Opportunity
 Growth of the Country

7. Advantages of capital
structure
 Greater Control and Flexibility
 Equity Advantages
 No liability to redeem
 Voting control right

8. Disadvantages of capital
structure
 Signal of capitalization
 High cost of fund raising
 Absence of close control
 No Investment by Cautious Investors

9. Capital Structure Theories
 MODIGLIANI AND MILLER APPROACH

10. MODIGLIANI AND MILLER APPROACH
 This approach was devised by Modigliani and
Miller during 1950s. Modigliani and Miller
advocate capital structure irrelevancy theory.
This suggests that the valuation of a firm is
irrelevant to the capital structure of a company.
Whether a firm is highly leveraged or has lower
debt component in the financing mix, it has no
bearing on the value of a firm.

11. ASSUMPTIONS OF MODIGLIANI AND
MILLER APPROACH
 There are no taxes.
 Transaction cost for buying and selling
securities as well as bankruptcy cost is nil.
 There is a symmetry of information.
 The cost of borrowing is the same for
investors as well as companies.
 There is no floatation cost like underwriting
commission, payment to merchant bankers,
advertisement expenses, etc.
 There is no corporate dividend tax.

12. MODIGLIANI AND MILLER
APPROACH
 PROPOSITION 1:
With the above assumptions of “no taxes”, the
capital structure does not influence the valuation
of a firm.
 PROPOSITION 2:
It says that financial leverage is in direct
proportion to the cost of equity. With an increase
in debt component, the equity shareholders
perceive a higher risk to for the company.

13. 2. Agency Theory:
 The agency theory is a supposition that explains
the relationship between principals and agents in
business. Agency theory is concerned with
resolving problems that can exist in agency
relationships due to unaligned goals or different
aversion levels to risk. The most common
agency relationship in finance occurs between
shareholders (principal) and company
executives (agents).

14. Contrasting Risk Appetites
 Another central issue dealt with by
agency theory handles the various
levels of risk between a principal and
an agent. In some situations, an agent
is utilizing resources of a principal.

15. Third Party Relationships
 An agency, in general terms, is the
relationship between two parties,
where one is a principal and the other
is an agent who represents the
principal in transactions with a third
party. Agency relationships occur
when the principals hire the agent to
perform a service on the principals'
behalf.

16. Relationship between agency
theory and capital structure:
Conflicts that impact the capital
structure
are:
 Management and owners’ interest conflict.
 Conflict of interest among owners, managers
and debt holders.