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Capital StructureA way a corporation finances itself through

some combination of equity and debt.

The capital structure should be designed with the aim of maximizing the market valuation of the firm in the long run.

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Determinants of Capital Structure Type of asset financed1. Ideally short term liabilities should be used

to create short term assets and long term liabilities for long term assets.

2. Else an AL mismatch may take place which may introduce an element of risk.

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Determinants of Capital Structure Nature of the Industry1. A firm relies more on long term debt and

equity if its capital intensity is high.2. If the business is seasonal in nature, needs

at seasonal peaks may be financed by short term debt.

3. Capital structure should be suitably designed keeping the nature of the industry.

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Determinants of Capital Structure Degree of Competition1. A business characterized by intense

competition and low entry barriers faces greater risk of earnings fluctuations. Equity financing may be more appropriate here.

2. A business characterized by less competition and high entry barriers faces lower risk of earnings fluctuations.

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Determinants of Capital Structure Obsolescence1. Key factors that lead to Obsolescence need to

be identified.2. Obsolescence can occur in products,

manufacturing processes, materials and even in marketing.

3. If chances of obsolescence are high, capital structure should be built conservatively.

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Determinants of Capital Structure PLC1. At the introduction stage, risks are high.

Therefore, equity is the primary source of finance. Financial leverage may not be affordable.

2. Growth phase – Risks may decrease but huge investments may be needed which may require doses of debt plus periodic induction of equity.

3. In maturity, leverage is likely to decline as cash flows accelerate.

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Determinants of Capital Structure Financial Policy1. Capital structure to be designed keeping in

mind the overall financial policy of the firm.2. The management might have decided on 2.1 Debt : Equity ratio 2.2 Dividend Payout 2.3 Debt Service coverage

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Determinants of Capital Structure Past and Present Capital Structure1. Determined by past events.2. Prior financing, investment, acquisitions, may

create conditions which may be difficult to change in the short run.

3. However medium to long term decisions to alter capital structure may be effected by issuing and retiring debt, issuing equity, equity buy backs, altering dividend policies etc.

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Determinants of Capital Structure Corporate Control1. Firms vulnerable to takeover are averse to

further issuance of equity as it can result in the dilution of the ownership stake.

2. Such firms place more reliance on debt.3. Firms with strong management (having

controlling stake) are unlikely to have reservations over further issue of equity.

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Determinants of Capital Structure Credit Rating1. Market assigns a great deal of weightage to the

credit rating of a firm. Hence obtaining a good rating has become imperative.

2. Market reacts negatively to any downgrading in the rating.

3. This may result in a denial of access to capital.

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Thank You

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