Definition:-

Capital Structure refers to the combination or mix of debt and equity which a company uses to finance its long-term operations.

By David Durand According to this theory a firm can increase the value of firm and reduce the over all cost of capital by increasing the proportion of debt in its capital structure to the max. possible extent.

First there are no taxes. Second the cost of debt is less than the

cost of equity. Third the cost of debt capital and cost

of equity capital remain constant.

A company’s expected annual EBIT is Rs. 50000. The company has Rs 2,00,000, 10% debenture. The cost of equity of the company

is 12.5%.

Net Operating Income (EBIT) Rs 50,000

Less: Interest on debentures (I) 20,000---------------------------

Earnings available to equity holders (EBT) 30,000

Equity Capitalization Rate (ke) 0.125

Market Value of Equity (S) = EBT/Ke ---------------------------- 2,40,000

Market Value of Debt (D) 2,00,000

Total Value of the firm (S+D) = V ------------------------------ 4,40,000

Overall cost of capital = Ko = EBIT/V (%) 11.36

By David Durand Net Operating Income (NOI) approach is the exact opposite of the Net Income (NI) approach.

According to this theory , the total market value of the firm (V) is not affected by change in the capital structure and the overall cost of capital(Ko) remain fixed irrespective of the debt equity mix.

Overall cost of capital is constant. The income tax does not exist. The business risk at each level of debt-

equity mix remain constant.

A company’s expected annual EBIT is Rs. 50000. The company has Rs 2,00,000, 10% debenture.

The cost of equity of the company is 12.5%.

Ko = (EBIT – I)/(V – D) or EBT/S= Earning available to equity

holders/Total market value of equity shares

Net Operating Income (EBIT) Rs. 50,000

capitalisation rate (Ke) 0.125-----------------------------

Total market value of the firm (V) = EBIT/Ke Rs 4,00,000

Total Value of Debt Rs 2,00,000

Total Market Value of Debt (S) = (V – D) Rs 2,00,000

Ko= 50,000 - 30,000 / 2,00,000 = 0.1 or 10%

By Ezra Soloman According to this theory a firm can reduce the overall cost of capital(Ko) or increase the total value of firm(V) of the firm by increasing the debt proportion in its capital structure to a certain limit .

EBIT = Rs. 150,000, presently 100% equity finance with Ke = 16%. Introduction of debt tothe extent of Rs. 300,000 @ 10% interest rate or Rs. 500,000 @ 12%. For case I, Ke = 17% and for case II, Ke = 20%. Find the value of firm and the WACCm.

Particulars Presently case I case IIDebt component - 300,000 500,000

Rate of interest 0% 10% 12%

EBIT 150,000 150,000 150,000

(-) Interest - 30,000 60,000

EBT 150,000 120,000 90,000

Cost of equity (Ke) 16% 17% 20%

Value of Equity(S= EBT / Ke) 937,500 705,882 450,000

Total Value of Firm ( S + D) 937,500 1,005,882 950,000

Ko =EBIT / V * 100 16.00% 14.91% 15.79%

THANK YOU PRESENTED BY: Ranjini Verma Sonu Sanklecha Preety Kashyap Rajani Kumari Nidhi Vats

PRESENTED TO: Mr. VIKAS JAIN (SIR)