Professional Documents
Culture Documents
of financing is adopted to serve the interest of the ordinary shareholders in a better way.
2. The importance of designing a proper capital
structure is explained below:
Value Maximization:
Capital structure maximizes the market value of a firm, i.e. in a
firm having a properly designed capital structure the aggregate
value of the claims and ownership interests of the shareholders
are maximized.
Cost Minimization:
Capital structure minimizes the firms cost of capital or cost of
financing. By determining a proper mix of fund sources, a firm can
keep the overall cost of capital to the lowest.
Increase in Share Price:
Capital structure maximizes the companys market price of share
by increasing earnings per share of the ordinary shareholders. It
also increases dividend receipt of the shareholders.
Investment Opportunity:
Capital structure increases the ability of the company to find new
wealth- creating investment opportunities. With proper capital
gearing it also increases the confidence of suppliers of debt.
3. sources of capital
here are various sources of finance such as equity, debt,
debentures, retained earnings, term loans, working capital
loans, letter of credit, euro issue, venture funding etc. These
sources are useful in different situations. They are classified
based on time period, ownership and control, and their source of
generation.
Sources of finance are the most explored area especially for the
entrepreneurs about to start a new business. It is perhaps the
toughest part of all the efforts. There are various sources of
finance classified based on time period, ownership and control,
and source of generation of finance.
Having known that there are many alternatives of finance or
capital, a company can choose from. Choosing right source and
the right mix of finance is a key challenge for every finance
manager. The process of selecting right source of finance involves
in-depth analysis of each and every source of finance. For
analyzing and comparing the sources of finance, it is required to
understand all characteristics of the financing sources. There are
many characteristics on the basis of which sources of finance are
classified.
On the basis of a time period, sources are classified into long
term, medium term, and short term. Ownership and control
classify sources of finance into owned capital and borrowed
capital. Internal sources and external sources are the two sources
of generation of capital. All the sources of capital have different
o
o
o
o
o
o
o
o
o
o
o
Financial Institutes
Government, and
Commercial Banks
Lease Finance
Hire Purchase Finance
Short Term Sources of Finance: Short term financing
means financing for a period of less than 1 year. Need for
short term finance arises to finance the current assets of a
business like an inventory of raw material and finished
goods, debtors, minimum cash and bank balance etc. Short
term financing is also named as working capital
financing. Short term finances are available in the form of:
Trade Credit
Short Term Loans like Working Capital Loans from
Commercial Banks
Fixed Deposits for a period of 1 year or less
Advances received from customers
Creditors
Payables
Factoring Services
Bill Discounting etc.
o
o
o
o
o
2. Dividend Policy
Given that the firm has control over its payout ratio, the
breakpoint of the MCC schedule can be changed. For example, as
the payout ratio of the company increases the breakpoint
between lower-cost internally generated equity and newly issued
equity is lowered.
3. Investment Policy
It is assumed that, when making investment decisions, the
company is making investments with similar degrees of risk. If a
company changes its investment policy relative to its risk, both
the cost of debt and cost of equity change.
Uncontrollable Factors Affecting the Cost of Capital
These are the factors affecting cost of capital that the company
has no control over:
1. Level of Interest Rates
The level of interest rates will affect the cost of debt and,
potentially, the cost of equity. For example, when interest rates
increase the cost of debt increases, which increases the cost of
capital.
2. Tax Rates
Tax rates affect the after-tax cost of debt. As tax rates increase,
the cost of debt decreases, decreasing the cost of capital.
5. how does the cost of capital influence the capital
structure
The primary factors that influence a company's capital-structure
decision are:
1. Business Risk