Capital structure

possible questions of capital structure, introduction of capital structure, meaning/definition of capital structure, best way to finance a company, optimal capital structure, designing an optimal capital structure, 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-

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? 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 Profitability Solvency Flexibility Conservatism Control Appropriate mix of these five features decide the appropriate capital structure.