FINANCIAL MANAGEMENT
MODULE II
Capital structure-theories of capital structure – MM model, incentive issues and agency cost; financial signaling;
Capitalization-under capitalization –over capitalization-capital gearing
Leverage – operating leverage-financial leverage
Cost –volume- profit analysis
PREPARED BY MRS. REKHA VENUGOPAL
Capital structure
In order to run and manage a company funds are needed. Right from the promotional stage up to end finance play an important role in a company’s life. If funds are inadequate the business suffers and if the funds are not properly managed the entire organization suffers. It is therefore necessary that correct estimates of the current and future need of capital be made to have an optimum capital structure which shall help the organization to run its work smoothly and without any stress.
Two principal sources of finance for a business firm are equity and debt and it is a permanent source of finance. Capital structure give answers to the questions like what should be the proportions of equity and debt in the capital structure of a firm. Or how much financial leverage should a firm employ?
Definition : According to Gerestenberg “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.” In the words of Nemmers and Grunewald “financial structure refers to all the financial resources marshaled by the firm, short as well as long term and all forms of debt as well as equity. Thus financial structure generally is composed of a specified percentage of short term debt and long tern debt and shareholders funds. To examine the relationship between capital structure and cost of capital the following simplifying assumptions are commonly made.
1. There is no income tax, corporate or personal taxes.
2. The firm pursues a policy of paying all of its
Capital structure-theories of capital structure – MM model, incentive issues and agency cost; financial signaling;
Capitalization-under capitalization –over capitalization-capital gearing
Leverage – operating leverage-financial leverage
Cost –volume- profit analysis
PREPARED BY MRS. REKHA VENUGOPAL
Capital structure
In order to run and manage a company funds are needed. Right from the promotional stage up to end finance play an important role in a company’s life. If funds are inadequate the business suffers and if the funds are not properly managed the entire organization suffers. It is therefore necessary that correct estimates of the current and future need of capital be made to have an optimum capital structure which shall help the organization to run its work smoothly and without any stress.
Two principal sources of finance for a business firm are equity and debt and it is a permanent source of finance. Capital structure give answers to the questions like what should be the proportions of equity and debt in the capital structure of a firm. Or how much financial leverage should a firm employ?
Definition : According to Gerestenberg “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.” In the words of Nemmers and Grunewald “financial structure refers to all the financial resources marshaled by the firm, short as well as long term and all forms of debt as well as equity. Thus financial structure generally is composed of a specified percentage of short term debt and long tern debt and shareholders funds. To examine the relationship between capital structure and cost of capital the following simplifying assumptions are commonly made.
1. There is no income tax, corporate or personal taxes.
2. The firm pursues a policy of paying all of its