Advertisements
Advertisements
Question
Write the external factors influencing capital structure.
Solution
- Market Condition: -The pattern of capital is also influenced by prevailing market conditions. Readiness of investors to purchase shares, interest rate, stages of business cycle, tax, risk of investment, etc together form market conditions.
- Attitude of Investor: -Attitude of investor also plays an important role in determination of capital structure. The investor s who is ready to take risk and expect higher returns prefer equity shares for investment. On the contrary, cautions investors, who are interested in safe and assured income, invest in debentures.
- Cost of Capital: -Cost of capital is one of the important factors while designing capital structure. The cost of capital is the minimum return expected by its supplier. The expected return depends upon the degree of risk. The high degree of risk is assumed by shareholders than debt holder. In case of debt holder, the rate of interest is fixed, while rate of dividend given to shareholder is not fixed.
- Government rules and regulation: -Statutory obligations play important role in capital structure decision. The SEBI has prescribed Debt: equity ratio norm of 2:1. A higher debt-equity ratio of 3:1 has been permitted for large capital intensive project. The small industrial projects are given concession and aid by government to avail more debt capital as compared to equity capital.
- Attitude of financial institution: -If financial institution prescribes high terms of lending, then management has to move to other source of financing. If financial institutions prescribe easy terms of lending, it would be advantageous to obtain funds at cheaper rate.
- Rate of Interest: -The prevailing rate of interest plays vital role in determining capital structure. If prevailing interest rates are higher, firms will delay debt financing. On the other hand, if prevailing interest rates are lower, firm will opt debt financing.
- Taxation: -Interest paid against debt is tax deductable expenditure. Dividend is not considered as tax deductable expenditure for the company. As such, issue of debt is more advantageous than issue of share capital.
- Competition:- The firm which are facing cut-throat competition prefer to issue equity shares because their earnings are not certain and adequate. But the companies which have monopolies may issue debt capital because of certainty of earnings.
APPEARS IN
RELATED QUESTIONS
Sakshi Ltd. is a company manufacturing electronic goods. It has a share capital ofRs 120 lakhs. The earning per share in the previous year wasRs 0.5. For diversification, the company requires additional capital ofRs 80 lakhs. The company raised funds by issuing 10% debentures for the same. During the current year the company earned profit ofRs 16 lakhs on capital employed. It paid tax @ 40%.
a. State whether the shareholders gained or lost in respect of earning per share on diversification. Show your calculations clearly.
b. Also state any three factors that favour the issue of debentures by the company as part of its capital structure.
What is meant by Capital Structure?
What is meant by Trading on Equity?
How does cost of equity affect the choice of capital structure of a company? Explain
How do ‘Floatation costs’ affect the choice of capital structure of a company? State
Explain the following as factors affecting the choice of capital structure:
Stock-Market conditions
Explain the following as factors affecting the choice of capital structure:
Flexibility
Explain the following as factors affecting the choice of capital structure:
Risk Consideration
Explain any four factors that affect the choice of capital structure of a company.
“Capital structure decision is essentially optimisation of risk-return relationship.” Comment.
Write the internal factors influencing Capital Structure.
Read the following text and answer the following questions on the basis of the same:
Mr. A. Bose is running a successful business. Mr. Bose is the owner of R. K. Cement Ltd. Mr. Bose decided to expand his business by acquiring a Steel Factory. This required an investment of Rs. 60 crores. To seek advice in this matter, he called his financial advisor Mr. T. Ghosh who advised him about the judicious mix of equity (40%) and Debt (60%). Employ more of cheaper debt may enhance the EPS. Mr. Ghosh also suggested him to take loan from a financial institution as the cost of raising funds from financial institutions is low. Though this will increase the financial risk but will also raise the return to equity shareholders. He also apprised him that issue of debt will not dilute the control of equity shareholders. At the same time, the interest on loan is a tax deductible expense for computation of tax liability. After due deliberations with Mr. Ghosh, Mr. Bose decided to raise funds from a financial institution.
“Mr. T. Ghosh who advised him about the judicious mix of equity (40%) and Debt (60%)”
The proportion of debt in the overall capital is called _______.
ICR = ______
Krish limited is in the business of manufacturing and exporting carpets and other home decor products. It has a share capital of ₹ 70 lacs at the face value of ₹ 100 each. Company is considering a major expansion of its production facilities and wants to raise ₹ 50 lacs. The finance manager of the company Mr. Prabhakar has recommended that the company can raise funds of the same amount by issuing 7% debentures. Given that earning per share of the company after expansion is ₹ 35 and tax rate is 30%, did Mr. Prabhakar give a justified recommendation?
Show the working.
State any three factors determining the choice of an appropriate capital structure of a company.
