The document discusses capital structure, which is the mix of debt and equity a company uses to finance its long-term operations, emphasizing its significance and the factors affecting it. It explores various approaches (net income, net operating income, and Modigliani-Miller) to determine optimal capital structure and discusses its impact on risk and return. Additionally, it highlights that there is no universally optimal capital structure, as it varies by firm and market conditions, and outlines features of an appropriate capital structure.

1. CAPITAL STRUCTURE
• What is Capital Structure and its importance?
• What are the determinants or factors that affect capital structure?
• Does optimal capital structure exists?
• Explain net income approach, net operating income approach and
MM approach assumptions, conceptual framework and criticism?
• Capital structure affects risk & return relationship? Do you agree?
• Compare Net Operating Income Approach with Net Income
Approach?
• Is traditional approach mixture of two? (Net operating income and
Net Income approach)
• Discuss MM Approach (Modigliani-Miller Approach). Explain it with
the help of arbitrage process?
• Can capital structure lead to winding up the company?
• Practical questions from all theories of capital structure

2. Introduction
• In financial management, estimating capital requirement and
its procurement is necessary and it is the role of every
financial manager. But the formation of capital structure is
important.
• For raising long term finance, company can issue three types
of securities-
Type of
securities
Owned Funds
Equity Shares
Preference
Shares
Borrowed Funds
(Debt Funds)
Debentures

3. continued…..
• Example :
Total capital requirement---------------10 Lacs
and the firm finance its capital requirement by
raising funds from long term sources available to
him. i.e. 6 lacs from equity shares and 4 lacs from
debentures. We call it as firm is 60% equity
financed and 40% debt financed.
Debt equity ratio---------------------------2:3

4. DEFINITION
“Capital Structure is the proportion of debt and equity mix
which a company uses to finance its long term operations.”
However, the proportion of each of these could vary from
business to business.
Note: Every security from which we raise money for business
has some cost associated with it. We often called it as cost of
capital. Whenever, an investor lend money to the firm either
by investing money in equity shares or debentures, he expect
something in return from his investment. Here we can note
that same capital becomes investment for an investor. So
when firm raise money, there is a cost associated with every
security. So minimum required rate of return becomes cost of
capital of the firm.

5. What is the best way to finance a company?
or
Is there an optimal capital structure for a company?
Optimal capital
structure
Maximize the value
of firm
Minimize the cost of
raising capital
(minimize the
weighted average
cost of capital)
But there is no fixed optimal capital structure for every organization. The optimal
capital structure differ from firm to firm. But the main objective behind finding out the
optimal capital structure should be that kind of capital structure which actually
maximize the value of the firm or the price of share in the market and it should
minimize the cost of raising capital.

6. Designing Optimal Capital Structure
Optimal capital structure depends upon how
well your market is doing. If your market is doing
well or if it is on growth path, your capital
structure can have more of debt. And if the
market is not doing well, then your capital
structure should have less debt.

7. Features of an Appropriate Capital
Structure
1. Profitability
2. Solvency
3. Flexibility
4. Conservatism
5. Control
Appropriate mix of these five features
decide the appropriate capital structure.