Financial Management

Different forms of capital structure

by shma

I have already discussed the meaning of capital structure. Today I will discuss the different forms of capital structure

  1. equity share capital only
  2. equity share capital + preference share capital
  3. equity share capital + long term debentures
  4. equity share capital + preference share capital+ long term debentures

The different forms of capital structure can be explained with the help of suitable example.

For example the company already has 2000 equity shares @ 100 each. The company needs more 30 lakhs.

i)                    the company can issue 30000 equity share @ 100 each

ii)                   the company can issue 10% debentures @ 100 each

iii)                 the company can issue 10% preference share @ 100 each

Earning before interest and tax is 10 lakhs, tax is 50%

I Case

II Case

III Case

EBIT

10

10

10

Less interest

-3(30000*10%)
Earning after interest before tax

=10

=7

=10

Less tax @ 50%

5

3.5

5

Less preference dividend

5

3.5

3
Earning available to equity shareholder

5 lakhs

3.5 lakhs

3 lakhs
Number of equity shares

50000

20000

20000
Earning per share

500000/50000=10

350000/20000=17.5

300000/20000=15

As per the II Case the earning per share (EPS) is the best which is the combination of equity + debentures.

Optimal capital structure

Optimal capital structure means the best combination of equity+ debentures+ preference share capital which helps in getting maximum value of firm and minimizes the cost of capital. To have optimal capital structure the firm must fulfill the following conditions:

i)                    return on investment should be greater than cost of investment

ii)                   there should be no financial risk

iii)                 the capital structure should be flexible

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