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| Corporate practice bd |
Capital structure
Capital structure refers to the mix of financing sources a company uses to operate and grow its business. It represents the way a company combines various forms of capital, such as equity and debt, to fund its operations and make investments. The two primary components of a company's capital structure are equity and debt, although some companies may also use other forms of financing like preferred stock or mezzanine financing.
Here's an overview of the key components of capital structure:
01.Equity:
Equity capital represents ownership in the company. It includes common stock and retained earnings. Common shareholders have a claim on the company's assets and earnings, and they typically have voting rights in the company's decisions. Retained earnings are profits that have been rein-vested in the company rather than distributed to shareholders as dividends.
02.Debt:
Debt capital is borrowed money that the company must repay, typically with interest. It can take various forms, such as bonds, loans, or other debt securities. Debt holders do not have ownership rights but do have a contractual claim on the company's assets and cash flows. The capital structure decision is essential for a company because it has a significant impact on its financial risk, cost of capital, and overall financial stability. Companies must strike a balance be-tween using equity and debt based on their specific needs, risk tolerance, and financial goals. Here are some considerations when determining the optimal capital structure:
01.Financial Risk:
Using more debt increases financial leverage but also raises the company's risk. High levels of debt can lead to financial distress if the company cannot meet its debt obligations.
02.Cost of Capital:
A company's cost of capital is the weighted average cost of equity and debt. An optimal capital structure minimizes the cost of capital, reducing the overall expense of financing operations and investments.
03.Flexibility:
Companies need to maintain financial flexibility to seize opportunities and weather economic downturns. Having too much debt can limit a company's ability to invest or adapt to changing market conditions.
04.Tax Considerations:
Interest payments on debt are often tax-deductible, which can make debt financing more tax-efficient than equity financing. This tax advantage can influence a company's capital structure decisions.
05.Market Conditions:
Economic conditions and investor sentiment can impact a company's ability to raise equity or debt capital. Companies may adjust their capital structure based on market conditions. Ultimately, the ideal capital structure varies from one company to another and can change over time as the business evolves. It's a crucial aspect of financial management and strategic decision-making for businesses.
Abbreviation
EBIT=Earnings before Interest & Tax
INT=Interest
TC=Tax rate
PD=Preferred Dividend
N.S= No. of share
EBT=Earning Before Tax
EAT=Earnings after Tax
EACS=
EPS=Earnings per share
Formula
01.Indiffernce point=(EBIT-INT) (1-TC)-PD /No. of share
Let’s start with Practical Example-(01)
MR X rahman collected capital amount TK.10,00,000 for expansion her business by two sources-
(i) Sales of share@ Tk100 each =TK.500000
(ii) 10% debenture = Tk.500000
Requirement:
1.No of share
2.Interest
Solution:
1.No of share =Old share + New share= (5000+5000) =10000 share
2.Interest =old+ new= (500000*10%)+0=50000
Practical Example-02
The capital structure of ABC company LTD is given below-
10% debenture = Tk.10,00,000
10% preferred stock =10, 00,000
Common stock =30,00,000
Total Amount = 50,00,000
The company needs additional financing of Tk.20,00,000. this can be finance by the following ways
Option (01) Fully equity stock of tk.100 each
Option (02) Fully 10% preferred stock
Option (03) Fully 12% preferred stock
The company expected EBIT is Tk.10,00,000 corporate tax 50% which alternative is the best and why
Requirement:
1.No of share
2.Interest
3.Preferred dividend
4.EPS
Solution:
[ When Fully equity stock of tk.100 each]
1.No of share =Old share + New share= (30000+20000) =50,000 share
2.Interest =old+ new= (1000000*10%)+0= 1,00,000
3.Preferred dividend =Old+ New= (1000000*10%)+0= 1,00,000
[ When Fully 10% debenture]
1.No of share =Old share + New share= (30000+0) =30,000 share
2.Interest =old+ new =10000+(2000000*10%)
=3,00,000
3.Preferred dividend =Old+ New= (10,0,0000*10%)+0= 1,00,000
[ When Fully 12% preferred stock]
1.No of share =Old share + New share= (30000+0) =30,000 share
2.Interest =old+ new= (1000000*10%)+0= 100000
3.Preferred dividend =Old+ New= 1,00,000+(200, 0000*12%)
=3,40,000
Table for Calculation of EPS
|
Particulars |
Option (01) |
Option (02) |
Option (03) |
|
EBIT |
1000000 |
1000000 |
1000000 |
|
Less (interest) |
100000 |
300000 |
100000 |
|
EBT |
900000 |
700000 |
900000 |
|
Less(Tax)@50% |
450000 |
350000 |
450000 |
|
EAT |
450000 |
350000 |
450000 |
|
Less(PD) |
100000 |
100000 |
340000 |
|
EACS |
350000 |
250000 |
110000 |
|
No. of share |
50000 |
30000 |
30000 |
|
EPS= EACS/N .S |
7 |
8.33 |
3.67 |
Comment:
The company should go for option (02) because option(B) has the height EPS others then.
Practical Example-03
The capital structure of ABC company LTD is given below-
Common stock =20,000 of TK 100 each Total TK.2,00,000It requires additional capital of Tk.5,00,000, in order to raised such capital, it has three following Alternatives-
Alternative (01) Issuing 5000 common stock of Tk.100 each
Alternative (02) 10% debt of TK.5,00,000
Alternative (03) 10% preferred stock@Tk.100 Tk.5,00,000
Assume corporate Tax rate is 50%
Requirement:
01.Find out EPS under each of the tree alternative if EBIT Tk.50,0,000
02. Indifference point of EBIT of Alternative-(01) and Alternative (02)
Solution:
[ Alternative (01) Issuing 5000 common stock of Tk.100 each]
1.No of share =Old share + New share= (20000+5000) =25,000 share
2.Interest =old+ new= (0+0) = 0
3.Preferred dividend =Old+ New= (0+0) =0
[ Alternative (02) 10% debt of TK.5,00,000]
1.No of share =Old share + New share= (20000+0) =20,000 share
2.Interest =old+ new =0+(500000*10%)
=50000
3.Preferred dividend =Old+ New= 0+0= 0
[Alternative (03) 10% preferred stock@Tk.100 Tk.5,00,000]
1.No of share = Old share + New share= (20000+0) =20,000 share
2.Interest =old+ new= (0+0) = 0
3.Preferred dividend =Old+ New= 0+(500000*10%)
=50000
Table for Calculation of EPS
|
Particulars |
Option (01) |
Option (02) |
Option (03) |
|
EBIT |
500000 |
500000 |
500000 |
|
Less (interest) |
000 |
50000 |
0000 |
|
EBT |
500000 |
450000 |
500000 |
|
Less(Tax)@50% |
250000 |
225000 |
250000 |
|
EAT |
250000 |
225000 |
250000 |
|
Less(PD) |
000 |
0000 |
50000 |
|
EACS |
250000 |
225000 |
200000 |
|
No. of share |
25000 |
20000 |
20000 |
|
EPS= EACS/N .S |
10 |
11.25 |
10 |
Comment:
The company should go for option (02) because option (02) has the height EPS others then.
01.Indifference point of EBIT of Alternative-(01) and Alternative (02)
We know that,
[ Alternative (01) Issuing 5000 common stock of Tk.100 each]
|
Option-01 |
Option-02 |
|
(I.P) = (EBIT-INT) (1-TC)-PD / N.S = |
(I.P) =(EBIT-INT) (1-TC)-PD / N.S |
|
= EBIT-0) (1-0.50)-0 /25000 = |
EBIT-50000) (1-0.50)-0 /20000 |
|
= EBIT*0.50/5 = |
(EBIT-50000) *0.50/04
|
|
= 0.50EBIT/5 =
|
0.50EBIT-25000 /4
|
|
= 2.50EBIT-1250000 =
|
2EBIT
|
|
= EBIT = |
250000
|
Verification table
|
Particulars |
Option-01 |
Option-02 |
|
EBIT |
250000 |
250000 |
|
Less: Interest |
000 |
50000 |
|
EBT |
250000 |
200000 |
|
Less: Tax 50% |
125000 |
100000 |
|
EAT |
125000 |
100000 |
|
Less: Preferred Dividend |
0000 |
00000 |
|
EACS |
125000 |
100000 |
|
N.S |
25000 |
20000 |
|
EPS=EACS/ N.S |
5 |
5 |