1 / 8

CAPITAL STRUCTURE

CAPITAL STRUCTURE. CAPITAL STRUCTURE. CAPITAL STRUCTURE IS A FIRM’S MIX OF DIFFERENT SECURITIES DEBT & EQUITY CASH FLOWS ARE SPLIT INTO TWO STREAMS SAFE STREAM TO BONDHOLDERS RISKY STREAM TO STOCKHOLDERS

asasia
Download Presentation

CAPITAL STRUCTURE

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. CAPITAL STRUCTURE

  2. CAPITAL STRUCTURE • CAPITAL STRUCTURE IS A FIRM’S MIX OF DIFFERENT SECURITIES • DEBT & EQUITY • CASH FLOWS ARE SPLIT INTO TWO STREAMS • SAFE STREAM TO BONDHOLDERS • RISKY STREAM TO STOCKHOLDERS • OBJECTIVE IS TO FIND THE MIX OF DEBT & EQUITY THAT MAXIMIZES THE FIRM’S OVERALL MARKET VALUE • FUNDAMENTALLY A MARKETING PROBLEM • IS IT WORTHWHILE TO TRY TO FIND OPTIMAL MIX? • PERHAPS THE MIX DOESN’T MATTER!

  3. CAPITAL STRUCTURE: OBJECTIVES • Explore the use of EBIT-EPS analysis as a tool of capital structure management • Examine theories of optimal capital structure, ie the relationship between capital structure and firm value • Understand the importance of the capital structure decision for a firm

  4. FINANCIAL STRUCTURE vs CAPITAL STRUCTURE • FINANCIAL STRUCTURE is the mix of all items that appear on the liabilities’ side of the firm’s balance sheet • CAPITAL STRUCTURE refers to the long-term sources of funds used by the firm

  5. BUSINESS RISK & FINANCIAL RISK • BUSINESS RISK the equity risk that comes from the nature of the firm’s operations • FINANCIAL RISK the equity risk that comes from the financial policy (ie the capital structure) of the firm

  6. EBIT-EPS ANALYSIS • The objective of EBIT-EPS analysis is to find the EBIT level that will equate EPS regardless of the financing plan chosen. • The limitation of EBIT-EPS analysis is that it considers only the level of the earnings stream and ignores risk.

  7. Calculation of Break-Even EBIT • EPS = (EBIT-I)(1-T)/No. of shares • Company A (no debt) (EBIT-0)(1-0.4)/4 million • Company B (with debt) (EBIT-£200,000)(1-0.4)/2 million • These are equal when: (EBIT-0)(1-0.4)/4 million= (EBIT-£200,000)(1-0.4)/2 million • With a little algebra, EBIT = £400,000

  8. EBIT-EPS ANALYSIS: SUMMARY • The effect of financial leverage depends upon EBIT • When EBIT is high, financial leverage raises EPS and ROE • The variability of EPS and ROE is increased with financial leverage

More Related