Trading on Equity The use of the fixed charges sources of funds such as debt and preference share capital along with the owner’s equity in the capital structure is described as “trading on equity” or “financial leverage” or “gearing”. The use of the fixed charges sources of funds such as debt and preference share capital along with the owner’s equity in the capital structure is described as “trading on equity” or “financial leverage” or “gearing”. Where debt capital is more than 50% of total capital it is called highly geared capital structure. Where debt capital is more than 50% of total capital it is called highly geared capital structure.

Long Term Capital sources Equity Shares: Equity Shares: Ordinary equity shares represent the ownership position in the company. Ordinary equity shares represent the ownership position in the company. The portion of profit given to equity shareholders are called “Dividend” The portion of profit given to equity shareholders are called “Dividend”

The Rights of Ordinary Shareholders attend general meetings of their company; attend general meetings of their company; vote on election of the directors of their company; vote on election of the directors of their company; vote on the appointment, remuneration and removal of auditors; vote on the appointment, remuneration and removal of auditors; receive the annual accounts of their company and the report of its auditors; receive the annual accounts of their company and the report of its auditors; receive a share of any dividend distributed; receive a share of any dividend distributed; vote on important matters such as a change in their company’s authorized share capital, the repurchase of its shares, or take-over bid; vote on important matters such as a change in their company’s authorized share capital, the repurchase of its shares, or take-over bid; receive a share of any assets remaining after their company has been liquidated; receive a share of any assets remaining after their company has been liquidated; participate in a new issue of shares in their company (the preemptive right) participate in a new issue of shares in their company (the preemptive right)

Preference shares It is often considered to be a hybrid security since it has both the advantages of ordinary shares and debentures. It is often considered to be a hybrid security since it has both the advantages of ordinary shares and debentures. Features:- Features:- * Dividend rate is fixed * Dividend rate is fixed * Dividends are not deductible for tax purposes * Dividends are not deductible for tax purposes * Preference shareholders have claims on income and assets prior to ordinary shareholders

Difference between Equity Capital and Preference capital Equity share holders are the owners of the company. They have the right to receive dividends. Preference share holders has the preference to get fixed rate of interest of profit for their shares. Equity share holders are the owners of the company. They have the right to receive dividends. Preference share holders has the preference to get fixed rate of interest of profit for their shares. preference share holders have no voting rights. but equity share holders have voting rights. preference share holders have no voting rights. but equity share holders have voting rights.

equity share holders who have a major no. of shares have a right to attend a board of director meeting but in case of preference share holders doesn't get any right. equity share holders who have a major no. of shares have a right to attend a board of director meeting but in case of preference share holders doesn't get any right.

Debentures A Debenture is a long-term debt instrument used by governments and large companies to obtain funds. It is similar to a bond except the securitization conditions are different. A debenture is usually unsecured in the sense that there are no liens or pledges on specific assets. It is however, secured by all properties not otherwise pledged. In the case of bankruptcy debenture holders are considered general creditors A Debenture is a long-term debt instrument used by governments and large companies to obtain funds. It is similar to a bond except the securitization conditions are different. A debenture is usually unsecured in the sense that there are no liens or pledges on specific assets. It is however, secured by all properties not otherwise pledged. In the case of bankruptcy debenture holders are considered general creditors

Term Loans Term loans represents long term debt with a maturity of more than one year. Term loans represents long term debt with a maturity of more than one year. They are obtained from banks and specially created financial institutions They are obtained from banks and specially created financial institutions They are generally obtained for financing large expansion, modernization or diversification projects. Therefore, this method of financing is called “ Project financing”. They are generally obtained for financing large expansion, modernization or diversification projects. Therefore, this method of financing is called “ Project financing”.

Capital Structure The capital structure of a company is the particular combination of debt, equity and other sources of finance that it uses to fund its long term financing. The capital structure of a company is the particular combination of debt, equity and other sources of finance that it uses to fund its long term financing. The capital structure is how a firm finances its overall operations and growth by using different sources of funds. The capital structure is how a firm finances its overall operations and growth by using different sources of funds.

DEFINITION. The permanent long-term financing of a company, including long-term debt, common stock and preferred stock, and retained earnings. It differs from financial structure, which includes short-term debt and accounts payable.long-termfinancing companylong-term debt common stockpreferred stock retained earningsfinancial structureshort-term debtaccounts payable

Capital Structure Theories Net Income Approach (NI Approach) Net Income Approach (NI Approach) *A firm that finances its assets by equity and debt is called a levered firm. On the other hand a firm that uses no debt and finances its assets entirely by equity is called unlevered firm. *A firm that finances its assets by equity and debt is called a levered firm. On the other hand a firm that uses no debt and finances its assets entirely by equity is called unlevered firm. *it is known as relevance approach. *it is known as relevance approach.

Assumptions Cost of Debt (Kd) and cost of equity (Ke) remain constand. Cost of Debt (Kd) and cost of equity (Ke) remain constand. Cost of Debt (Kd) is always lesser than cost of equity (Ke). Cost of Debt (Kd) is always lesser than cost of equity (Ke). Value of the firm(V) =value of debt + value of equity Value of the firm(V) =value of debt + value of equity V= B+ S V= B+ S B = value of debt ; S = value of equity B = value of debt ; S = value of equity Value of equity= Equity Earnings Value of equity= Equity Earnings cost of Equity cost of Equity

Cost of equity is also known as equity capitalization rate. Cost of equity is also known as equity capitalization rate. Equity earnings = EBIT- Interest Equity earnings = EBIT- Interest EBIT= Earnings Before Interest and Tax EBIT= Earnings Before Interest and Tax Interest is calculated on Debenture capital Interest is calculated on Debenture capital Ko(overall cost of capital)= EBIT Ko(overall cost of capital)= EBIT V

Net Operating Income Appraoch Value of the firm(V) =EBIT Value of the firm(V) =EBIT Ko Ko Value of equity= Value of the firm – Value of debt Value of equity= Value of the firm – Value of debt cost of Equity = Equity Earnings cost of Equity = Equity Earnings Value of Equity Value of Equity Ko=(Kd X Value of debt ) + ( Ke X Value of equity ) Ko=(Kd X Value of debt ) + ( Ke X Value of equity ) Value of the firm Value of the firm Value of the firm Value of the firm

Traditional Approach Value of firm = value of equity + value of debt Value of firm = value of equity + value of debt Value of equity= equity earnings Value of equity= equity earnings cost of equity cost of equity