INTRODUCTION

0 Definition

Capital Structure: According to Gerestenbeg, Capital structure of a company refers to the composition or make up of its capitalization and it includes all long term capital resources, viz: loans,reserves,shares and bonds . Meaning: Capital structure is made up of debt and equity securities. It is the permanent financing of the firm. It is composed of long term debt, preference share capital and share holders funds.

CAPITALISATION
0 Meaning: Capitalisation refers to the total amount of securities issued by a company.

While capital structure refers to the kind of securities and the proportionate amounts that make up capitalisation.

FINANCIAL STRUCTURE
Definition: According to Nemmers and Grunewald, Financial structure refers to all the financial resources marshalled by the firm, short as well as long term, and all forms of debt as well as equity. Thus financial structure composes of a specified percentage of short term debt , long term debt and share holder s funds.

 a) b) c)

From the given information compute : Capitalisation Capital Structure Financial Structure

Liabilities Equity share capital Preference share capital Long term loan and debentures Retained earnings Capital surplus Current liabilities

Rs. 15,00,000 7,00,000 3,00,000 5,00,000 60,000 2,50,000 3,31,000

Solution:
a) Capitalisation refers to the total amount of securities issued by a company . It is computed as below:

Particulars Equity share capital Preference share capital Long term loans and debentures Capitalisation

Rs. 15,00,000 7,00,000 3,00,000 25,00,000

b) Capital structure : Capital structure refers to the proportionate amount that make up capitalisation. Particulars Equity share capital Preference share capital Long term loans and debentures Retained earnings Capital surplus Rs. 15,00,000 7,00,000 3,00,000 5,00,000 60,000 30,60,000

3) Financial structure refers to all the financial resources, short as well as long term and is calculated as :

Particulars Equity share capital Prefernce share capital Long term loans and debentures Retained earnings Capital surplus Current liabilites

Rs. 15,00,000 7,00,000 3,00,000 5,00,000 60,000 2,50,000 31,10,000

PATTERN OF CAPITAL STRUCTURE

(a)Equity Shares only (b)Equity and Preference Shares (c)Equity Shares and debentures (d)Equity Shares, Preference Shares and Debentures

ESSENTIAL FEATURES OF SOUND CAPITAL MIX

Maximum possible use of leverage The capital structure should be flexible. To avoid undue financial/business risk with the increase of debt The use of debt should be within the capacity of the firm.the firm should be in a position to meet its obligations in payin the loan and interest charges as and when due. It should involve minimum possible risk of loss of control. it must aviod undue restrictions in agreement of debt.

FACTORS DETERMINIG THE CAPITAL STRUCTURE

Financial leverage or trade on equity Growth and stability of sales Cost of capital Cash flow ability to service department Nature and size of the firm Control Flexibility Requirement of investors. Capital market conditions Asset structure Purpose of financing Period of financing Cost of flotation Personal considerations Corporate tax rate Legal requirements

EBITEBIT-EPS ANALYSIS
Is an approach which helps in designing the optimum capital structure for the company or the firm To design various alternatives of debt, equity and preference shares in order to maximize the EPS at a given level of EBIT


It examines how different capital structures affect earnings available to shareholders (Earning Per Share).

 It is the analysis of the effect of financing alternatives on earnings per share.  To design the capital structure of the firm in such a way so as to minimize the cost of capital.  EBIT-EPS analysis is a method to study the effect of leverage under alternative methods of financing.

CALCULATION OF EBIT
Sales : xxxxx (-)V.C : xxx =Contribution : xxxxx (-)F.C : xxxx =EBIT (Earning Before Interest and Taxes)

CALCULATION OF EPS
EBIT : xxxxx (-)INTEREST : xxx =EBT : xxxxx (-)TAX : xx =Earning for Equity shareholders : xxxxx () No. of E.S : xxx = EPS {Earning Per Share} xxx

 The company has the following schemes : 2000, 5% Debentures of Rs 100 each 2000, 8% P. Shares of Rs 100 each 2000, Equity shares of Rs 100 each The company has a share capital of 4,00,000 of Rs.100 each. The company is in need of Rs 2,00,000 for purchasing a new equipment and it is estimated that additional investment will also produce 10% earning before interest & taxes every year. EBIT is Rs.1,20,000 The company has asked your advice as to whether the requisite amount be obtained in the form of 5% Debenture or 8% P. Shares Or equity shares of Rs 100 each to be issued at par. Examine the problem in all its bearing and advice firm if the Corporate tax rate is 50%.

ALTENATIVES
Particulars i Debenture 1,20,000 10,000 ii P. Share 1,20,000 ---iii Eq. Share 1,20,000 ------

EBIT (-)Interest

STATEMENT SHOWING THE EPS UNDER EXISTING & PROPOSED 1,10,000 1,20,000 1,20,000 EBT ALTERNATIVE 55,000 60,000 60,000 (-)Tax 50%
EAT (-)P. Dividend ESH
() No. of Equity Shares

55,000 ---55,000 4,000 Rs 13.75

60,000 16,000 44,000 4,000 Rs 11.0

60,000 ----60,000 6,000 Rs 10.00

EPS

Conclusion: Out of the three options available, the 1st option is the best as the EPS is Rs. 13.75.

 ABC Co. has currently an ordinary share capital of Rs.25,00,000 consisting of 25,000 shares of Rs.100 each. The management is trying to raise another Rs.20,00,000 to finance a major program of expansion through one of 4 possible financial plans. The options are: 1) Entirely through ordinary shares. 2) Rs.10,00,000 through ordinary shares and Rs.10,00,000 through long term borrowings at 8% interest p.a. 3) Rs.10,00,000 through ordinary shares and Rs.10,00,000 through preference shares with 5% dividend. The company s expected earnings before interest and tax will be Rs.8,00,000. Assuming a corporate tax of 50%. Determine the EPS in each alternative and comment which alternative is best and why..

Particulars

EBIT (-)Interest EBT (-)Tax 50% EAT (-)P. Dividend ESH

() No. of Equity Shares

8,00,000 ----8,00,000 4,00,000 4,00,000 ---4,00,000 45,000 Rs 8.89

8,00,000 80,000 7,20,000 3,60,000 3,60,000 ---3,60,000 35,000 Rs 10.29

8,00,000 -----8,00,000 4,00,000 4,00,000 50,000 3,50,000 35,000 Rs 10.00

EPS

Conclusion: Out of the three options available, the 2nd option is the best as the EPS is Rs. 10.29.

 From the following financial data of companies A and B, prepare the income statement

Particulars Variable cost as % of sales Interest expenses Degree of operating leverage Degree of financial leverage Fixed cost Income tax rate

A 50% 500 8/1 3/1 2000 50%

B 80% 600 5/1 6/1 1000 50%

Solution:
To calculate EBIT : Company A F.L. = EBIT EBIT- I 3 = EBIT 1 EBIT-500 3EBIT-1500=EBIT 3EBIT-EBIT=1500 2EBIT=1500 EBIT=750 To calculate Contribution: Company A O.L.=Contribution EBIT 8= Contribution 1 750 Contribution=750x8 Contribution=6000 Company B F.L. = EBIT EBIT-I 6= EBIT 1 EBIT-600 6EBIT-3600=EBIT 6EBIT-EBIT=3600 5EBIT=3600 EBIT=720

Company B O.L.= Contribution EBIT 5 = Contribution 1 720 Contribution=720x5 Contribution=3600

To calculate Contribution In terms of %: Company A: Contribution=Sales-V.C. Contribution=100-50 Contribution=50% Company B: Contribution=Sales-V.C. Contribution=100-80 Contribution=20%

Calculation of Sales: Company A: Sales=Contributionx100/% of Contribution =6000x100/50 =12000

Company B: Sales=Contributionx100/% of Contribution =3600x100/30 =18000

Income statement

Particulars Sales (-) V.C. Contribution (-) F.C. EBIT (-) Interest EBT (-) Tax 50% EAT

A 12000 6000 6000 2000 4000 500 3500 1750 1750

B 18000 14400 3600 1000 2600 600 2000 1000 1000