The objective of the firm should be directed towards the maximization of the value of the firm the capital structure, or average, decision should be examined from the point of view of its impact on the value of the firm. With the help of notes, candidates can plan their strategy for particular weaker section of the subject and study hard. We will use the current market value of each source of capital based on its current, not historical, costs. Structural models in corporate finance address the valuation of corporate securities both debt and equity. These notes on financial management can be downloaded by clicking on the pdf icon below. For now, we will assume we know the relevant opportunity cost of capital or discount rate.
Aswath damodaran 3 the objective in decision making n in traditional corporate finance, the objective in decision making is to maximize the value of the firm. Capital structure detailed notes financial management unit 3. Capital structure and its 4 important theories ni, noi. Capital structure wharton finance university of pennsylvania. The long term investment may be termed as fixed investment.
While developing capital structure, finance managers must also consider the financial and operating leverages of the firm. Structure theories capital structure capital structure is the proportion of debt and preference and equity shares on a firms balance sheet optimum capital structure is that at which the weighted average cost of capital is minimum and thereby maximum value of the firm traditional approach the traditional approach argues that moderate degree of debt can lower the firms overall. So, go ahead and check the important notes for class 12 business studies financial management. Theories of capital structure explained with examples. The goal of this chapter is to discuss the various theories that help to explain the determination of capital structure. Alex shapiro 1 lecture notes 9 the capital asset pricing model capm i. A lucid and detailed introductory study notes on the topic capital structure. I will also share the lecture notes on this subject.
In this case it will be said that the capital structure of the company consists of. This decision in a private enterprise is directed towards the achievement of maximization of the shareholders wealth or value of the firm. The network structure of social capital 349 mechanisms enter the analysis. A read is counted each time someone views a publication summary such as the title, abstract, and list of authors, clicks on a figure, or views or downloads the fulltext. Modiglianimiller theorem under some assumptions, corporate. Basic concepts in daily life, we nd ourselves in constant contact with internationally traded goods. Project should not be charged for paintingmachine time 5. Initial investment includes capital expenditure and wc 2. We can integrate by parts the previous equation between time 0 and time tto obtain. It is the employment of an asset source of finance for which. Pdf the study of venture capital financing process for. Capital structure theory asks what is the optimal composition between debt and. Capital structure, dividend policy and valuation b40. The capital structure of a company is made up of debt and equity securities that comprise a firms financing of its assets.
The structure of prior relations among people and organizations in a market can affect, or replace, information. You may be wearing clothing made in china or eating fruit from chile. A major part of the longterm funds is invested in the fixed assets. When cost of capital is lowest and the value of the firm is greatest, we call it the optimum capital structure for the firms and at this point, the market price per share is maximised. It is the permanent financing of a firm represented by longterm debt, preferred stock and net worth. Intratemporal and intertemporal first order conditions. Lecture notes on risk management, public policy, and the. The patterns of corporate capital structures around the world are also discussed. So it relates to the arrangement of capital and excludes shortterm borrowings. Lecture 12 capital structure capital structure theory capital structure. Lecture notes course home syllabus calendar readings. Capital structure theory asks what is the optimal composition between debt and equity. Meaning of capital structure capital structure refers to the combination or mix of debt and equity which a company uses to finance its long term operations. Testing a new capital structure theory the depression baby theory of.
It is synonymously used as financial leverage or financing mix. Key concepts and skills definition of capital structure. The capital structure puzzle is unravelled and a clear picture is presented in terms of why capital structure matters. Project should be charged for cannibalization of regular widget sales 6. Estimate the opportunity cost of each source of financing.
Raising of capital from different sources and their use in different assets by a company is made on the basis of certain principles that provide a system of capital. The essential corporate finance text, updated with new data. Note that the parameters, and l may be chosen endogenously. Corporate finance has long been a favourite among both students and professionals in the field for its unique blend of theory and practice with a truly global perspective.
The relationship among capital structure cost of capital and value of firm had always been one of the. They received the nobel prize in economics in 1990 the value of the firm is determined by the cash flows to the firm and the risk of the assets. Securitization outline introduction to securitization securitization structure. With equity, you do get whatever cash flows are left over after you have made debt payments. Financing the firms assets is a very crucial problem in every business and as a general rule there should be a proper mix of debt and equity capital in financing.
Valuation of corporate securities depends on their cash flows, which in turn are contingent. Financial management is about analysing financial situation making financial decision setting financial objectives. Capital budgeting under risk and uncertainties chapter7. The capital structure decision can affect the value of the firm either by changing the expected earnings or the cost of capital or both. Define the firms capital structure by determining the weight of each source of capital. Sometimes the above data is difficult to obt ain this is the main weakness of al l dc f techniq ues.
Capital structure denotes means a firm funds its operations using some blend of equity plus debt. Depression babies are sometimes defined as people born in. Capital structure is the mix of ownersupplied capital equity, reserves, surplus and borrowed capital bonds, loans that a firm uses to finance business operations. Financial management ebook,lecture notes,pdf download for. The study of venture capital financing process for reaching a vc and factors impacting their decisions. Notes on capital structure pdf capital structure cost of capital. The capital structure is how a firm finances its overall operations and. Capital structure is the proportion of all types of capital viz. Financial management lecture notesebook for 4th semester. Fin 401 capital structure overview ryerson university duration. He notes that when firms are on the verge of bankruptcy, there is no incentive for shareholders to invest more equity capital, even if positive npv projects are. The value of an enterprise depends on expected earnings and cost of capital. Chapter 14 the cost of capital texas tech university.
Capital structure and leverage, lecture notes financial. It is the minimum rate of return the firm must earn overall on its existing assets. Capital structure notes selfinstructional 126 material used for the mix of capitalization. According to ni approach a firm may increase the total value of the firm by lowering its cost of capital. Risk analysis in capital budgeting optimal capital budget capital budgeting strategic business plan. The theory of capital structure is closely related to the firms cost of capital. Theories of capital structure ppt capital structure.
Chapter iii concepts and theories of capital structure and profitability. This ebook is highly recommended for mba or management students. The capital structure of a company refers to a containation of the longtermfinances used by the firm. Modiglianimiller theorem financing decisions are irrelevant. Go to recent capital structure litera ture when deciding about the correct data. Candidates who are pursuing in class 12 are advised to revise the notes from this post. It is interesting to note that the estimated empirical average tax rate.
Docx capital structure and the cost of equity capital modigliani and miller mm developed a theory of capital structure. The uses of funds of a concern can be divided into two parts namely longterm funds and short term funds. Hi guys, i am sharing with you this excellent ebook on financial management in pdf format. Find materials for this course in the pages linked along the left. Lecture notes financial management sloan school of. Compared to the simple frictionless capital model, the user cost of capital features. The term capital structure refers to the relationship between the various longterm forms of financing such as debenture, preference share capital and equity share capital. The capital structure puzzle is unravelled and a clear.
Capital structure is also referred to as the degree of debts in the financing or capital of a business firm. Irrelevance theorem a benchmark striking result is that under fairly general conditions, the value of the firm defined as the sum of value of debt and. The choices and the trade off neither a borrower nor a lender be. The finance function, the investment decision, capital structure decisions, dividend decisions, management of current assets. Corporate finance lecture note packet 2 capital structure. There is no difference between pretax and aftertax equity costs. When the stock is traded and markets are viewed to be efficient, the objective is. Capital budgeting evaluation techniques 112 chapter6. Kandir, balcilar, and onal 2009 notes that managements first priority is to evaluate the various costs and benefits associated with the use of both debt and equity. Replacement happens when market information is so ambiguous that people use network structure as the best available information. Cbse notes class 12 business studies financial management. Capital structure theories introduction capital structure decision is a significant decision in financial management.
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