capital structure

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Information about capital structure

Published on October 9, 2009

Author: punitha


Capital Structure : Capital Structure Meaning: Capital Structure refers to the combination or mix of debt and equity which a company uses to finance its long term operations. Fundamental Principles:- Cost principle Control principle Return principle Flexibility principle Timing principle Optimal Capital Structure : Optimal Capital Structure The optimal or the best capital structure implies the most economical and safe ratio between various types of securities. It is that mix of debt and equity which maximizes the value of the company and minimizes the cost of capital. Characteristics of optimal capital structure:- : Characteristics of optimal capital structure:- Simplicity Low cost Maximum return & minimum risk Maximum control Liquidity Flexibility Equitable capitalization Optimum leverage Pattern of capital structure : Pattern of capital structure Exclusive equity Equity & preferred stock Equity & bonds Equity, bonds & preferred stock Capital structure decision factors : Capital structure decision factors Internal Factors : Internal Factors Size of Business Nature of Business Regularity and Certainty of Income Assets Structure Age of the Firm Desire to Retain Control Future Plans Operating Ratio Trading on Equity Period and Purpose of Financing External Factors : External Factors Capital Market Conditions Nature of Investors Statutory Requirements Taxation Policy Policies of Financial Institutions Cost of Financing Seasonal Variations Economic Fluctuations Nature of Competition Basic Ratio : Basic Ratio Sound or Optimal Capital Structure requires (an approximation):- Debt Equity Ratio: 1:1 Earning Interest Ratio: 2:1 During Depression: one and a half time of interest. Total Debt Capital should not exceed 50 % of the depreciated value of assets. Total Long Term Loans should not be more than net working capital during normal conditions. Current Ratio 2:1 and Liquid Ratio 1:1 be maintained.

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