capital structure theory refers to a systematic approach to financing business activities through a combination of equities and liabilities Capital structure is also referred as the degree of debts in the financing or capital of a business firm

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Evaluation of Capital
Structure Theories Around
The World

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Introduction
• capital structure theory refers to a systematic
approach to financing business activities
through a combination of equities and
liabilities
• Capital structure is also referred as the
degree of debts in the financing or capital of a
business firm

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Capital structure theories
• NET-OPERATING INCOME THEORY
• Net income approach
• Traditional theory
• Signalling theory
• Modigliani And Miller's theory

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Result of survey

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impacts
• Advertisements can create anxiety for both men and women by
actively portraying men as hyper-masculine and women as ultra-
thin
• Psychological disorders such as body dysmorphic disorder,
anorexia, and bulimia

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impacts
• Unrealistic expectations by men of how women should look or
behave
• The excessively coercive nature of appeal to strong sexual instincts
to sell products or promote media

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impacts
• Ads tend to restrain both women and men to stereotypical
gender roles
• Ads Depict women as inferior to men in cognitive ability

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Net income approach

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Net income approch
• Net Income Approach suggests that value of the firm can be
increased by decreasing the overall cost of capital (WACC)
through higher debt proportion.
• The theory suggests increasing value of the firm by
decreasing the overall cost of capital which is measured in
terms of Weighted Average Cost of Capital. This can be done
by having a higher proportion of debt, which is a cheaper
source of finance compared to equity finance.

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Net income approch

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Net income approch

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Traditional Theory

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Traditional Theory
• a proper and right combination of debt and equity will always
lead to market value enhancement of the firm
• also known as “intermediate approach”
• The rate of interest on debt remains constant for a certain
period and thereafter with an increase in leverage, it
increases

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Traditional Theory
The above exercise shows that increasing the debt reduces
WACC, but only to a certain level. After that level is crossed, a
further increase in the debt level increases WACC and reduces the
market value of the company.

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Signaling Theory

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Signaling Theory
• signaling is the idea that one party (termed the agent)
credibly conveys some information about itself to another
party (the principal)
• in Michael Spence's job-market signaling model, (potential)
employees send a signal about their ability level to the
employer by acquiring education credentials.

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MODIGLIANI & MILLER Theory

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Assumptions
• There are no taxes. But latter on 1969 they remove this
assumption.
• Transaction cost for buying and selling securities as well as
bankruptcy cost is nil.
• There is a symmetry of information. This means that an investor
will have access to same information that a corporate would and
investors would behave rationally.
• The cost of borrowing is the same for investors as well as
companies.
• Debt financing does not affect companies EBIT.

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Calculation of value of company
Value of Unlevered firm
• Vu = EBIT(1 – T)/Ke
Value of Levered Firm
• VL = Vu + Dt

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Criticism
• According to this theory there is no
transaction cost but sometimes there is
transaction cost in the market
• M&M theory is true when market is perfectly
efficient but all market is not perfectly
efficient.
• There is no tax cost, not all countries but
most of countries market have tax cost.

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ANY QUESTIONS??
Thank you!