This document discusses capital structure and dividend policies. It defines capital structure as the permanent financing of a firm through long-term debt, preferred stock, and equity. It lists factors to consider when planning capital structure and describes the features, benefits, and drawbacks of debt and equity. It also discusses leverage, types of leverage including operating, financial, and combined leverage. Finally, it covers different dividend policies like stable dividend policy and stable dividend payout policy.

1. Capital Structure Decisions-B.V.Raghunandan, SVS College, Bantwal-Karnataka-India

2. Meaning & Definition of Capital StructureCapital Structure is, ”the permanent financing of the firm represented by long-term debt, preferred stock and networth” -Weston & Brigham

3. Planning the Capital StructureFactors to be considered 1. Liquidity 2. Profitability 3. Ownership Control 4. Leverage 5. Nature of Industry 6. Funding Agencies’ Suggestions 7. Timing 8. Tax Planning 9. Growth Plans 10. Strategy

4. DebtAny source that gives the funding agency the creditorship statusIn 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 SheetIn the vertical format, it is the II item (which again contains Secured Loans and Unsecured Loans) on the side of Sources of Funds

5. Features of DebtCompulsory Payment of InterestCompulsory RepaymentOnly Fixed InterestNo Annual ReportsNo Voting Rights

6. Merits of DebtBenefit of LeverageCost of Raising FundsTax AdvantageManagerial StabilityEasier SEBI NormsFlexible FeaturesStable Market for SecuritiesManageable Administrative ExpensesFlexible RepaymentEasier Regulatory Compliance

7. Demerits of DebtCompulsory Payment of InterestSolvency AffectedCompulsory RedemptionCharge on AssetsCredit Rate Shopping

8. Equity Shareholders Fund or Ownership CapitalCompulsory Component of the Capital StructureSum of Equity Share Capital, Preference Share Capital and Reserves and SurplusPreference Shares are not a Popular Instrument

9. Equity SharesCommon Stock/Ordinary SharesFull Fledged OwnershipTotal Entitlement to the AssetsRepayment After the Satisfaction of Every Other ClaimPreemptive RightEntitlement for Dividend, Bonus Shares and Other Such Rewards

10. Benefits of Equity SharesBasic for Capital StructureBetter SolvencyGestation PeriodNo RedemptionNo Charge on AssetsNo Shopping for Credit RatingEvaluation of Share ValueBetter ImageCreation of ValuePublic Knowledge of Financial Information

11. Demerits of Equity SharesTax ImplicationManagement ControlHigh Rates of DividendLack of FlexibilityStringent SEBI NormsHuge Issue ExpensesHigh Volatility in the Stock MarketSpeculationComplex Shareholder- Management RelationRigid Corporate Governance

12. Trading on EquityTrading on Equity is, "the use of borrowed funds or preferred stock for financing” -Guthmann & Dougal

13. Significance of Trading on EquityA company having an ROI greater than the k can achieve a higher EPS for the equity shareholdersA company having a lower ROI than the k, will suffer financially because of inability to meet the fixed interest commitment

14. Preparation of Statement of IncomeLeverages: Operating Leverage, Financial Leverage and Combined LeverageDegree of LeveragesSignificance of Each Leverage: -Sales-EBIT-EPS Relation -Measurement of Risk Levels -Behaviour of Costs

15. Proforma of a Statement of Income

16. Computation of Earning per Share

17. Problem No.1Show the EBIT for the following set of data: P=Rs.10, Q= 20,000 V= Rs.6 F=50,000 (July,2006)Solution:EBIT=S-V-F = (20,000x10)-(20,000x6) – - 50,000 = Rs.30,000

18. LeveragesLeverage is the benefit that accrues to the equity shareholders due to debt (carrying fixed rate of interest) or preference shares (carrying fixed rate of dividend)Trading on Equity is the cause and Leverage is the effectThree Types of Leverages: Operating Leverage, Financial Leverage and Combined Leverage

19. Operating LeverageIt is a benefit derived by the presence of fixed cost in the cost of manufacturingIt helps in determining the magnifying impact of a certain percentage of increase in sales on the EBITAn operating leverage of 2 indicates that a 10% increase in sales will result in 2x10%,i.e 20% increase in the EBIT

20. Financial LeverageIt is the benefit derived due to fixed interest or fixed dividend securities in the capital structure of the companyIt is measure that helps us in determining the magnified impact of a certain percentage of increase in the EBIT on the EPSA Financial Leverage of 3 indicates that a 10% increase in the EBIT results in a 30% increase in the EPS

21. Combined/Total LeverageIt is the total benefit derived from operation and financing due to fixed costs and fixed dividend or fixed interestIt measures the magnifying impact of a certain percentage of increase in sales on the EPSA combined leverage of 5 indicates that for every 10% increase in sales, there will be a 50% (5x10%) increase in EPS

22. Determination of Operating Leverage (OL)

23. Determination of Financial Leverage (FL)

24. Determination of Combined Leverage

25. ProblemsA company sells 40,000 units at Rs. 50 per unit. Variables cost is Rs. 40 per unit, and the fixed cost is 2,00,000. Compute the operating leverageThe sales of a company amounted to Rs. 60,000 and the variable cost was 30%. of sales. Fixed cost was Rs. 32,000. Compute the operating leverage

26. Problems------2The EBIT of a firm was Rs. 75,000 and the interest burden was Rs. 50,000. Applicable tax rate was 40%. Compute the Financial LeverageA firm has an operating leverage at 2.5. If the sale increases by 10%, Calculate the percentage of increase in EBIT (Operating Profit).

27. Problems-------3If the Operating Leverage is 3 and financial leverage is 2, what is the combined leverage? If the sales increase by 35%, what will be the percentage of increase in the EPS?

28. Problems----------4Calculate operating leverage, financial leverage and composite leverage from thr following data Sales(1,00,000 units)- Rs.2,00,000 Variable Cost/unit - Rs.0.70 Fixed Cost - Rs.65,000 Interest Charges - Rs.15,000 (July, 2006)

29. Problems------------5Calculate DOL, DFL,DCL for the three firms from the data given below and interpret the results P Q ROutput(units) 3 lakh 75,000 5 lakhFixed Cost(Rs)3.5lakh 7lakh 75,000VC/Unit (Rs) 1.00 7.50 0.10Interest (Rs)25,000 40,000 -Price/Unit (Rs) 3.00 25.00 0.50 (June,2005)

30. Dividend PoliciesInvolves distribution of Cash Dividend and declaration of Bonus sharesCash Dividend distributed decides the image of the corporate in the marketMay decide the market priceAlso has an impact on the valuation of sharesAlso decides the profit retained in the firm

31. Factors Affecting the Dividend PolicyCorporate PolicyStable earningsLiquidity of the CorporatePast dividend RatesPresent ProjectsMarket ExpectationTaxationLegal restrictionBonus NeedsInvestment OpportunitiesRestrictions of FIsNature of BusinessCost of CapitalPhase of Trade CycleAcc.ReservesGrowth Needs

32. Types of Dividend PoliciesStable Dividend PolicyStable Dividend Pay-Out Policy

33. Stable Dividend PolicyThe percentage of Dividend is kept stableThe increase in percentage is only moderate over a long period of timeStable Image for the CorporateStability in the market priceEasy management of liquidityHelps in Building up the ReservesEasy maintenance of the Rate over a long period

34. Stable Dividend Pay-Out PolicyA certain percentage of the surplus profit is distributed year after yearHigher surplus results in a higher percentageShareholders enjoy during periods of growth and prosperity and suffer during recessionFluctuating market PriceLeading to Speculation in the trading in the shares

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