Financial management

Añadido: 2026-05-20

[00:00:00]good morning students so today we are going to discuss about A New Concept that is factors affecting the choice of capital structure factors affecting the choice of capital structure so in the previous class we discussed U about the capital structure I told you that capital structure is nothing but a mix of owners as well as the borrowed fun so in the business organization it is is a very tough task to know or to decide regarding what amount of owner fund and what amount of borrowers fund should be available or has to be available in the business organization so excess use of uh uh what Equity or excess use of owners fund and excess use of borrowers fund is a problem to the business organization like it has both merits as well as Dem merits okay so um it's like today we are going to discuss about the factors affecting the choice of capital structure so what are the factors that affect the choice of capital structure so like I told you deciding about the capital structure of a firm um it involves determining the relative proportions of various types of fund so uh I like I told you debt maybe or the equity so debt requires regular servicing so uh interest payment has to be done on a regular basis and repayment of principles are obligatory on a business so in addition uh a company planning to raise debt must be uh must have sufficient cash to meet the increased outflow because of higher debt so similarly uh there are like when coming to your Equity also there are certain things uh which becomes a drawback for the organization so deciding about the capital structure of the firm uh is very important or what amount of debt or equity in the organization has to be available in the business organization is very important so the important factors which determine the choice of capital structure are one is cash flow position so the important factors which determine the choice of capital are one is uh cash flow position so when coming to uh cash flow position coming to uh uh cash flow position it's like uh yeah the size of projected cash flow must be considered before borrowing the projected cash flow must be considered or taken into consideration before borrowing so cash flow position is very important so what amount of cash available or what amount of cash flow is uh in the business organization is very important so cash flow it must not only cover fixed cash payment obligation but also there must be a sufficient buffer yes so cash flow must not only cover fixed Capital fixed cash payment fixer so there must be buffer show available in the business organization must not only cover the fixed capital or cash payment obligation but also there has to be sufficient amount of buffer so it must be kept in mind that the company has cash payment obligation it must be kept in mind that the company has cash flow what um cash flow obligation is it has to be kept in mind that the company has cash flow obligation so obviously you should know or you should think about the cash flow obligation so only when there is a proper cash flow in the organization yes so the normal working of the business organization gets done in a proper work the normal working uh that is normal business operation maybe or for investing the what capital or for investing on the fixed assets or for meeting The Debt Service commitments yes for payment of Interest cash in flow becomes very important like I told you cash flow you have to keep in mind that the company has have I mean has to have a good amount of cash flow or cash flow is so that the cash payment obligations can be raed so must be kept in mind that a company has a cash payment obligation for normal business operations for investment in fixed assets for meeting The Debt Service commitments yes for payment of Interest maybe or for repayment of principle maybe so for all these things cash flow in the business organization is very important like I told you uh cash flow uh it should cover the cash cash payment obligation or fixed cash payment available in the organization or obligations available in the organization so flows Inu so the second one is interest coverage ratio that is icr interest coverage ratio so the interest coverage ratio refers to number of times earning before interest and tax of a company covers the interest obligation so interest obligation interest obligation the number of times the earning before interest and tax that is epit yes that is ebit so how many times or what number of times earning before interest and tax of the company covers the internal or interest obligation interest obligation interest obligation so how many times or it refers to the number of times earning before interest and taxes of company covers the interest obligation yes the number of times the earning before EB I mean interest in tax that is ebit covers yes ebit for company covers in interest obligation so this can be calculated with the ex this one that is the formula okay so what is that formula IC that is interest coverage ratio icr is equal to ebit divided by interest icr is equal to EB divid interest ebl so interest coverage ratio so icr it is interest coverage ratio is equ Al to ebit ebit divided by interest icr is equal to ebit divided by interest ebit divided by interest e e i equal e interest so the higher ratio the lower shall be the risk of the company failing to meet the interest payment obligation interest coverage risk of company uh failing to meet the interest obligation reduces so higher the ratio lower shall be the risk of company failing to meet it meet its interest payment obligation okay so it's like U yeah it's like um The Firm may have a I ebit but low cash balance a firm uh may have ibid but low cash balance so apart from interest repayment obligation are relevant apart from interest the repayment obligations are relevant so higher the ratio lower shall be the risk of company failing to meet its interest payment yes higher the ratio lower shall be the comp uh mean Ro shall be the risk of the company failing to meet the interest payment obligation okay lower shall be the yeah lower uh shall be the risk of company failing to meet the interest obligation so risk sorry okay so a firm have I mean a firm may have a higher ebit but low cash balance apart from interest repayment obligations are relevant apart from interest the repayment obligation is totally [Music] irrelevant so the Third third one is debt service coverage ratio debt service coverage ratio so when coming to your debt coverage or debt service coverage ratio that is dscr so debt coverage or debt service coverage ratio or dscr takes care of deficiency referred to in the interest coverage ratio so interest deficiency IC so this debt service coverage ratio debt service coverage ratio it uh takes care of the deficiency which is referred uh referred uh in the or yeah refer to in the uh your interest coverage ratio so icr that is interest coverage ratio so debt service coverage ratio or dscr it takes care of the deficiency referred to in the icr so icr interest coverage ratio def Debt Service cage takes care about the your what icr or the deficiency which is provided or which is show in the icr so concentrate so the cash profits generated by operations are compared with the total cash required for the service of the debt and the preference share Capital yes the cash profits generated by operations yes the cash profits which are generated by operations cash profit which are generated by operations are compared with the total cash yes they are compared with the total cash required for the service of debt total cash required for the service of debt so the cash profit generated by the operations cash profits generated by the operations generated by the operations the cash profits generated by the operations are compared with the total cash are compared with the total cash required for the service of debt and preferen Sh Capital cash profit cash profit generated yes the cash profit generated by operations they compared the total cash required to service both the debt and the preferential Capital sot prefer yes okay so the cash profit is compared with the total cash required yes it is compared with the total cash required to service debt and preference share capit cap so how is this calculated D service coverage Rao calculate so there is a Formula yes so dscr is equal to DSR is equal to profit after tax plus depreciation profit after tax plus depreciation Plus interest plus noncash expenses profit after tax plus depreciation plus interest plus non-cash expense divided by divided by preference dividend plus interest plus repayment obligation divided by preference dividend plus interest plus repayment obligation so DSR is calculated the formula so the formula is profit after tax plus depreciation plus interest plus non-cash expense divided by preference dividend plus interest plus repayment obligation so the IR the dscr that is debt service coverage ratio uh it indicates or the higher dscr it indicates better ability to meet the cash commitment so D it indicates the better ability of the organiz ation to meet the cash commitments indicates better ability to meet the cash commitments and consequently the company's potential to increase debt components in its capital structure so higher dscr indicates better ability to meet cash commitments better ability to meet cash commitments and consequently the company uh company's potential to increase debt component in its capital structure so the next one is return on investment return on investment so when coming to your return on investment so if the return on investment of a company is higher yes it can uh use trading on Equity to increase its EPS so return on investment company return on investment yes on inv it can choose to use trading on Equity yes it can choose to use trading on Equity so the reason why it can choose trading on Equity is to increase the EPS is to increase the EPS so its ability to use debt is greater its ability to use debt is greater its ability to use debt is greater so we have already observe oberved uh like we have already spoken about the return on investment in the previous classes okay so I told you about the return on investment when I was explaining about your uh ebit that is your capital structure Capital return on investment so I told you like the company it can use more debt to increase its EPA so uh yeah the company can use more debt to increase its CA so um it becomes easy so chose it Roi or return on investment is important determinant of the company's ability to use trading on Equity so this is the capital structure so I told you what is trading on Equity so it is nothing but increase the profit earned by the equity shareholders trading on Equity is nothing but increase in profit earned by the equity shareholders due to presence of fixed Financial charges due to presence of fixed Financial charges so on investment so this is all about your return on investment so the next one is cost of debt fifth one is cost of debt so when coming to your cost of debt firm's ability to borrow at a lower rate the firm's ability to borrow at a lower rate rate the firm's ability to borrow at a lower rate increases its capacity increases its capacity to employ higher dat firm's ability to borrow at a lower rate the firm's ability to borrow at a lower rate increases its capacity the firm's ability to borrow at lower rate increases its capacity to employ higher debt increases its capacity to employ higher debt so more debt can be used if debt can be raised at lower rate more debt can be used if debt can be raised at lower rate so firm's ability to borrow at a lower rate increases its capacity a firm's ability to borrow at a lower rate increases its capacity uh capacity to employ higher de so more debt can be used if debt can be raised at lower rate so yes when firm has an ability to raise at lower debt can be raised when the debt can be raised at a lower rate so firm's ability to borrow at a lower rate increases it capacity when a firm has the ability to borrow uh what yeah borrow at a lower rate increases its capacity to employ a higher deity when it can buy when it can buy de it lower rate then it's buying capacity is more It's ability is more so more debt can be used if debt can be be raised at lower R what you can do is like you can take loan when the organization can raise more debt with lower rate yes then obviously the organization can go with raising the debt at lower rate so the next one is tax rate so when coming to your tax rate so since uh interest is directable expense since interest is a deductible expense so cost of debt is affected by tax cost of debt is affected by taxed so since interest is a deductible expense so as interest is aable expense so cost of debt is affected by the tax rate so the firm in mean yeah in example is borrowing so the firm is borrowing 10% since the tax rate is 30% yes the firm um in the example is buying at 10% yes okay so 10% interest rate there and the tax rate is 30% and after tax cost of debt is only 7% after tax the cost of debt is only 7% after tax cost of debt 7% after tax the cost of debt is only 7% so the higher tax rate um yeah tax rate this makes debt relatively cheaper so Yaga I mean relatively cheaper and it increases its attraction yes okay so higher tax rate makes debt relatively cheaper sobt cheap so this is all about your tax rate so the tax rate or increase is I mean yeah interest is a deductable expense so cost of debt is affected by the tax rate cost of debt is affected by the tax rate so example borrowing is 10% yes borrowing 10% tax 30% yes after tax the cost of debt is only 7% so after tax earning after tax ad earning after tax ad the cost of debt is only 7% the cost of thatt is only 7% so the seventh one is cost of equity the seventh one is cost of equity so when coming to your cost of equity so the stock owners they expect a rate of return from Equity yes they expect a rate of return from equity which is compensate with the risk they are assuming yes stock owners they expect a rate of return from the equity from the equity which is compensate with the risk they are assuming so when a company increases debt when a company increases debt the Financial Risk faced by the equity holders the Financial Risk faced by the equity holders increases yes company increase when a company increases debt the Financial Risk faced by the equity holders increases burden Equity holders Financial Risk it faced by the equity holders totally increases so subsequently subsequently subsequently their desired rate of return may increase their desired rate of return may increase so it is for this reason that company cannot cannot use debt Beyond a point so it is for this reason the company cannot use debt Beyond a point there is a remit for what raising Equity as well as debt so okay so if debt is used beyond that point the cost of equity may go up yes and share price May decrease in in spite of increased EPS so eps cost of equity cost of equity that totally increases the earning per share so earning per share totally decreases consquently for maximization of shareholder weth shareholders wealth debt can be used only up to a level so consequently for maximization of shareholders wealth for maximization of shareholders wealth debt can can be used only up to a level debt can be used only up to a level okay so so the next one e eth one is flotation cost so when coming to flotation cost the process of raising resources also involves some cost obviously the process of raising resources it involves some amount of cost so the public issues of shares and debentures public issues of shares and debentures requires a considerable expenditure public issue of shares and debenture requires a considerable expenditure so getting a loan from financial institutions getting a loan from financial institutions may not cost so much yes so so process of raising resource it cost or it involves some amount of cost Pro process of raising resource it involves some amount of cost so public issue of shares and debentures requires considerable expenditure public issue of shares and debentures public issue of shares and debentures it requires considerable expenditure okay so getting a loan from financial institution getting a loan from a financial institutions may not cost so much so these considerations may also affect the choice between the debt and equity and hence the capital structure public issue of shares and debentures requires considerable expenditure issue of Shar it reques considerable expenditure so getting a loan from financial institution may not cost so much so Equity Equity loans or getting loan from the financial institutions may not cost so much so you have to be uh def I mean deciding regarding which one to opt so these considerations may also affect the choice between the debt and Equity so deity you have to take a proper decision relating to that so the next one the ninth one is uh risk consideration so uh Financial Risk uh like I told you Financial risk is available in the business organization so use of debt it increases the financial risk of the business so Financial Risk so Financial Risk it refers to the position Financial Risk refers to a position when a company is unable to meet its fixed Financial charges Financial Risk refers to a position when a company is unable to meet its fixed Financial charges when the company is unable to meet its fixed Financial charges so it may be uh interest payment or it may be preference dividend and your repayment obligation this Financial Risk refers to position where the company is unable to meet the fixed Financial charges Financial fixed Financial charges that's called as Financial Risk so apart from the financial risk every business organization as some operating risk yes so Financial Risk business organization has certain amount of operating risk so business risk it depends upon the fixed operating cost business risk totally depends upon the fixed operating cost so higher fixed operating cost result in higher business risk yes higher fixed operating cost leads or higher fixed operating cost results in higher business risk so operting risk so the total risk depends upon both the business and the Financial Risk the total risk totally depends both on both on the business risk and Financial Risk so the next one is flexibility so when coming to flexibility so if a firm uses it debt potential to the full yes the firm uses its debt potential to the fullest extent so it loses I mean it loses the flexibility to issue further debt poti it loses the flexibility to issue further debt okay so it must maintain some borrowing power it must maintain some borrowing power so the reason why it it is said that it has to maintain some borrowing power is that to take care of unfortun circumstances unfor circum so the flexibility in the organization it totally reduces to a greatest exent so that is why it is said that so the 11th one is control so uh when coming to your control so death uh I mean sorry debt normally does not cause a dilution of control d control does not get diluted in debt yes so public issue of equity share totally reduces the management Holdings in the company yes management Holdings in the company make it vulnerable to take over this Factor also influences the choice between the debt and Equity especially in companies in which current Holdings of management is on a lowerings they have to think whether to go on with debt ority because they don't have any voting power yes so the 12th one is uh regulatory framework so when coming to regulatory framework regulatory framework so every company uh it has a regulatory framework and it operates within the regulatory framework which is provided by law [Music] okay yes soel so raising funds from bank and other financial institutions they require certain Norms which has to be fulfilled so Now function yes it may be through bank or through financial institutions they have certain Norms which has to be fulfilled so the relative isase with which these Norms can be met or the procedures completed may also have a bearing about the choice of source of it affects the what raising of funds it leads to choice of source of fund so whether it has to be on Equity equity in the raise mod debt in the raise mod so the 13th one is stock market condition so when coming to your stock market condition so if the stock markets are bullish if the stock market are bullish equity share holders are more easily or Equity Shares are more easily sold even at higher price sold easily even ateret okay so here it's like uh use of equity is often preferred by companies in such a situation use of uh Equity is often preferred by companies in such a situation so during a bearish phase yes okay so company may find raising the equity more difficult so bullish very easily but but when it is bearish when the market is bearish in nature so it may find or the company may find Raising Equity Capital more difficult okay so at that particular situation what a company will do is like it will opt for that it will go on with the debt it will go on with the debt so stock market condition totally fects the choice between these debt and Equity stock market decisions like it bring certain changes so the last one is capital structure of other companies capital structure of other companies so when coming to your capital structure of other companies though the useful guidelines in capital structure planning is debt equity ratio of other companies in the same uh industry so useful guideline in the capital structure planning is the debt equity ratio of other companies the same industry so there are usually some industry Norms which may help uh care however which may help okay so there must be or it has to be taken that the company does not follow the industry nms blindly the company does not what follow the industry Norms Bly so it simply says that the useful guideline in the capital structure planning is a debt equity ratio of other companies in the same industry so there has to be or there are usually some industry Norms which may help in the organization so there must be or you have to be taken or it must be taken into consideration that the company does not follow the industry Norms blindly so if the business risk of a firm is higher it can not afford the same Financial Risk fin so it should go on with for loaded so management must know what the industry Norms are whether they are following them or deviating from them the adequate justification must be there in both cases you should have a thorough knowledge about the what Norms okay so you can't follow the industry Norms blindly you can't follow the industrial Norms blindly so business risk like I told you is a form I mean yeah is like it is a form which brings problem to the organization so business uh risk of a form is higher so when it is higher then it can not afford more Financial Risk so Financial Risk will have to moving data