The document discusses capital structure, which refers to the composition of a firm's financing sources, primarily long-term debt, preferred stock, and net worth. It outlines various theories related to capital structure, including the net income, net operating income, traditional, and Modigliani-Miller approaches, highlighting their assumptions and implications on a firm's risk, cost of capital, and overall value. Key determinants affecting capital structure encompass the firm's nature, earning stability, lifecycle stage, cash flow ability, and tax considerations.

1. WELCOME
presented by
Yogavathi H S
Frist M. com
Govt. first grade college
for women hnp

2. CAPITAL STRUCTURE

3. Capital structure
o Capital structure forms part of the study of financing
decision
o Financing decision is concerned with the procurement
of the required long- term funds at the proper time.
o Financing decision is concerned with the
indentification of the sources from which funds can be
raised and the determination of the amount of funds
that can be raised from each source.
o Thes aspects of financing decision make up the
structure of an enterprise.

4. Definition and meaning of capital structure
According to C.W.Gerstenberg, the term ‘capital
structure ,refers to the make –up, from or composition
of a firm`s capitalization , i.e, the types of securities to
be issued and the relative proportion of each type of
securities in the total capitalization”.
In the words of weston and brigam, “capital structure
is the permanent financing of the ration of the firm
represented by long term debt, preferred stock , and
net worth”.

5. Importance
 Capital structure determine the risk assumed by the
firm
 Capital structure determine the cost of capital of the
firm
 It affect the flexibility and liquidity of the firm
 It affect control of the owner of the firm

6. DITERMINANT OF CAPITAL STRUCTURE
 Nature and size of the firm
 Stability of the earning
 Stages of life cycle of the firm
 Cash flow ability of the firm
 Cost of capital
 Rate of corporate tax
 Retainig control
 Flexibility
 Trading on equity

7. APPROCHES OR THEORIES OF CAPITAL
STRUCTURE
1. Net Income approach or theory
2. Net operating Income approach or theory
3. Traditional approach or theory
4. Modigliani –miller approach or theory

8. NET INCOME (NI) APPROACH
• This theory is suggested by “David Durand”
• Acc. to this approach the value of the firm is
increass and decrease overall cost of capital by
increasing the proportion of debt financing in capital
structure
• It due to the fact that debt id generally a cheaper
sources of finance because :
1. Interest rate are lower than the dividend rate
2. Benefit of tax because int. is deductible expense

9. ASSUMPTION OF NET INCOME APPROACH
The cost of debt is lower than cost of equity
The risk perception of the investor is not changed by
the use of debt
There is no corporate tax

10. The effect of leverage on the cost
of capital under NI approach

11. NET OPERATING INCOME APPROACH
 This theory was propounded by “ David Durand” and
is also known as irrelevant theory.
 Acc . To this theory, the total market value of the firm
is not affected by the change in the capital structure
and the overall cost of capital remain constant
irrespective of debt – equity ratio

12. ASSUMPTION OF NET OPERATING
INCOME APPROCH
THE market capitalizes the value of the firm as a whole
. Thus ,the split between debt and equity is not
important.
The cost of debt is lower than cost of equity
The risk perception of the investor is not changed by
the use of debt
There is no corporate tax

13. The effect of leverage on the cost of capital
under NOI approach

14. TRADITIONAL APPROACH
 This approach is the midway of NI approach and NOI
approach. And also known as intermediate approach.
 Acc. To this, the value of firm can be increased initially or
cost of capital can be decreased by using more debt as the
debt is a cheaper source of fund than equity.
 After that optimum capital structure can be reached by a
proper debt- equity mix .

15. TRADITIONAL APPROACH

16. MODIGLINI – MILLER APPROACH
 They have given two approach
 In the absence of corporate taxes
 When corporate taxes exist
ASSUMPTION
 Capital market are perfect
 Homogeneous risk classes of firm
 Expectations about the net operating income
 100% payout ration
 No corporate tax

17. Thank you