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TRADITIONAL APPROACH-Capital Structure

  TRADITIONAL APPROACH-Capital Structure Meaning The Traditional Approach to capital structure states that there is an optimum capital structure at which the overall cost of capital (WACC) is minimum and the value of the firm is maximum . According to this approach: A firm can increase its value by using debt in a reasonable proportion along with equity. Debt is cheaper than equity because interest on debt is tax-deductible and lenders take lower risk. However, excessive use of debt increases financial risk and the cost of equity. Therefore, a proper debt–equity mix is required to achieve an optimum capital structure. Assumptions: Cost of debt remains constant up to a certain level. Cost of equity increases with increased financial risk. Moderate use of debt reduces overall cost of capital. Beyond the optimum point, excessive debt increases WACC and reduces firm value. Tips to Solve Tradition...
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PRACTICE QUESTIONS AND ANSWER - CAPITAL STRUCTURE

  PROBLEMS ON CAPITAL STRUCTURE Problem:1 A company needs Rs.6,00,000 for construction of a new plant. The following three financial plans are feasible. 1)       The company may issue 60,000 equity shares of Rs.10 each. 2)       The company may issue 30,000 equity shares of Rsf. 10 each and 3000 debentures of Rs. 100 each bearing 8% coupon rate of interest. 3)       The company may issue 30,000 equity shares of Rs. 10 each and 3000 preference shares of Rs. 100 each bearing 8% coupon rate of interest. Earnings before interest and taxes (EBIT) are expected to be Rs.1, 50,000. Corporate tax is 50%. Calculate the earnings per share (EPS) under three plans. Which plan would you recommend and why? Problem:2 Alpha company   Ltd., has an all equity capital structure consisting of 20,000 equity shares of Rs.100 each. The management plans to raise Rs.30 lakhs to finance a program of expansion....
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Net Operating Income _Problem and Solution

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Problem Deva Ltd., has an EBT of Rs.4,50,000. The cost of debt is 10% and outstanding debt is Rs.12,00,000.  The overall   Capitalisation rate is (Ko) is 15%. Calculate the total Value of the firm and Equity Capitalisation Rate under NOI approach. Solution           i.            1.  Calculation of the Market Value of the firm( V)                                    Value of the Firm(V)= Rs.30,00,000       ii.           2.   Calculation of Market Value of Equity(S) S=Market Value of firm (V) - Market Value of Debt S=30,00,000-12,00,000 Value of Equity=Rs.18,00,000     iii.             3. Calculation of earnings available to Equity shareholders     Earning...
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