Optimal Capital Structure Definition, What is Optimal Capital Structure, and How Optimal Capital Structure works?

The present value of ‘P’ of the amount ‘A’ due at the end of ‘n’ conversion periods at the rate ‘i’ per conversion period. The period after which interest becomes due is called ‘interest period’ or ‘conversion period’. If conversion period is not mentioned, https://1investing.in/ interest is to be compounded annually. The formula used for compounding of interest income over ‘n’ number of years. If interest for one period is added to the principal to get the principal for the next period, it is called ‘compounded interest’.

optimum credit term exists when

There may be a time lag between the demand for the material and its supply. Similarly, it may not be possible to produce the goods instantly after they are demanded by the customers. The need to hold work-in-progress may arise due to production cycle. The operational objective difference between apt and capm is to uphold enough inventory, to meet demand for product by efficiently organizing the firm’s production and sales operations. Various items of payments may be differed till they affect the smooth running of the operation and at the same time, damage the goodwill of the firm.

Key Points in Designing an Optimal Capital Structure

The cost of equity capital Ke, remains constant more or less or rises gradually up to a certain level and thereafter increases rapidly. Under this approach, the most significant assumption is that the Kwis constant irrespective of the degree of leverage. The segregation of debt and equity is not important here and the market capitalises the value of the firm as a whole.

When new projects are added to the firm the firm value is the sum of the old value plus the new. Above the indifference or break-even point the increase in EPS for all equity plans is greater than debt-equity plans. Above the indifference or break-even point the increase in EPS for all equity plans is less than debt-equity plans.

The payment from customers should be converted into cash without any delay, i.e., managing float to speed up collection. In order to manage cash efficiently, the process of cash inflow can be accelerated through systematic planning and refined techniques. Precautionary balances are the cash balances which are held as reserve for random and unforeseen fluctuations in cash flows, i.e., this motive implies the need to hold cash to meet unpredictable obligations. The more predictable the cash flows, the less precautionary balances that are needed and vice-versa. The following points highlight the top five models of cash management of working capital.

Budget hopes for FinTech: Boost credit flow for MSMEs

Issue of shares is the most important source for raising the permanent or long-term capital. A company can issue various types of shares as equity shares, preference shares and deferred shares. According to the Companies Act, 1956, however, a public company cannot issue deferred shares.

  • The answers to the first and second questions are given with reference to the capital investment appraisal decisions made by the top management.
  • While deciding capital structure the financial conditions and psychology of different types of investors will have to be kept in mind.
  • The period for which finance is needed also influences the capital structure.

What will be the price of Shake if Dividend is not declared. Presume Company pays dividend and has to make new Investment of $48,000 in the coming Period. How many new shares be issued to Finance Investment Programme as per M.M.

Six ways you can use credit card for optimum credit score

Decrease in investment in current assets also increases the volume of risk. The higher the proportion of fixed charge bearing fund in the capital structure of a firm, higher is the Degree of Financial Leverage and vice-versa. The percentage change in the earning per share to a given percentage changes in earnings before interest and taxes is defined as Degree of Financial Leverage . We are, now, going to examine the effect of corporate taxes in the capital structure of a firm along with the MM Hypothesis. So, according to MM, the total value of a firm is absolutely unaffected by the capital structure (debt-equity mix) when corporate tax is ignored. The sudden withdrawal of debt funds from the company can cause cash insolvency.

Since wealth of owners is reflected in the market-value of shares; wealth maximisation means the maximisation of the market price of shares. Accordingly, wealth maximisation is measured, by the market value of shares. Discarding the profit-maximisation objective; the real basic objective of financial management, now-a-days, is considered to be wealth maximisation. Wealth maximisation is also known as value-maximisation or the net present worth maximisation. Likewise, the Advertising Manager thinking, in terms of launching an aggressive advertising programme, is too, considering a financial decision; and so on for other functional managers.

optimum credit term exists when

The first step involved in Capital Budgeting is to select the asset, whether existing or new on the basis of benefits that will be derived from it in the future. Arrangement must be made for required fund from different sources in advance which needs careful planning. For example, a pharmaceutical firm is to make plans for a shorter period since its equipment’s are short-lived whereas a mining firm has to make a plan for a longer period. It means if a firm accepts one project, it may rule out the necessity for others i.e., the alternatives are mutually exclusive and only one is to be chosen. For example, we know that interest charges are deducted from profit available for dividend, i.e., it is tax deductible.

The cost of capital for a firm with no debt in its capital structure. Firms also prefer to hold them to protect against the risk of unpredictable changes in demand and supply forces. For example, the supply of raw material may get delayed due to the factors like strike, transport disruption, short supply, lengthy processes involved in import of the raw materials. Firm may hold the inventories in order to facilitate the smooth and continuous production and sales operations. It may not be possible for the company to obtain raw material whenever necessary.

How SBI Card users can increase their credit card limit

The percentage change in EPS to a given percentage change in sales is defined as Degree of Combined Leverage . The higher the proportion of fixed operating cost and financial charges, higher is the degree of combined leverage. Like other two leverages the value of combined leverage must be greater than 1.

  • They feel the price of share of a Company is determined by its earning potentiality and investment policy and never by the pattern of Income Distribution.
  • Income from equity investment i.e. 10% of Earnings available for equity shareholders i.e. 10% of ` 7500 or ` 750.
  • The equity of the shareholders in the corporation increases.
  • This source of finance is more suitable to meet the medium-term demands of working capital.

Stability of dividend policy does not mean stagnation in dividend pay-out ratio. In fact, slow but steady change is the prime feature of stable dividend policy. The corporation may have earnings but may find it inadvisable to pay cash dividends. The declaration of a stock dividend will give the stock holders evidence of the increase in their investment without interfering with the company’s cash position. If the stock holders prefer cash to additional stock in the company, they can sell the stock received as dividend.

Indeed there will be transfer of the amount of dividend from the surplus account to the capital stock account which amount to capitalization of retained earnings. The net effect of this would be an increase in number of shares of the current stockholders but there will be no change in their total equity. Cash dividends are, by far, the most popular form of dividend. In cash dividends, stockholders receive checks for the amounts due to them. Cash generated by business earnings is used to pay cash dividends. Sometimes, the firm may issue additional stock to use proceeds so derived to pay cash dividends or bank may be approached for the purpose.

Explain the term working capital. What is the primary objective of working capital management?

In management of working capital, the cost of capital may be used to calculate the cost of carrying investment in receivables and to evaluate alternative policies regarding receivables. The financial manager makes estimates of funds required for both short-term and long-term. Profit arises due to many factors such as pricing, industry competition, state of the economy, mechanism of demand and supply, cost and output. A healthy mix of variable and fixed factors of production can lead to an increase in the profitability of the firm. Financial Management is all about planning, organizing, directing, and controlling the economic pursuits such as acquisition and utilization of capital of the firm. To put it in other words, it is applying general management standards to the financial resources of the firm.

Leave a Comment

Your email address will not be published. Required fields are marked *