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Unit 7: Capital Structure Decision
Mahesh Kumar Sarva, Lovely Professional University

Unit 7: Capital Structure Decision Notes

CONTENTS
Objectives
Introduction

7.1 Meaning of Capital Structure
7.2 Major Considerations in Capital Structure Planning
7.3 Value of the Firm and Capital Structure
7.4 Capital Structure Theories

7.4.1 Net Income (NI) Approach
7.4.2 Net Operating Income (NOI) Approach
7.4.3 Modigliani–Miller’s Approach (Extension of NOI Approach)
7.5 Effects of a Financing Decision on Earnings Per Share

7.6 Summary
7.7 Keywords
7.8 Review Questions
7.9 Further Readings

Objectives

After studying this unit, you will be able to:
 Define the capital structure
 Recognize the conception of optimum capital structure
 Explain the different considerations in capital structure planning
 Describe the theories of capital structure.

Introduction
Organizations have need of funds to run and maintain its business. The requisite funds may be
raised from short-term sources or long-term sources or a combination both the sources of funds,
so as to equip itself with an appropriate combination of fixed assets and current assets. Current
assets to a considerable extent, are financed with the help of short-term sources. Normally, firms
are expected to follow a prudent financial policy, as revealed in the maintenance of net current
assets. This net positive current asset must be financed by long-term sources. Hence, long-term
sources of funds are required to finance for both (a) long-term assets (fixed assets) and
(b) networking capital (positive current assets). The long-term financial strength as well as
profitability of a firm is influenced by its financial structure. The term ‘Financial Structure’
refers to the left hand side of the balance sheet as represented by “total liabilities” consisting of
current liabilities, long-term debt, preference share and equity share capital. The financial
structure, therefore, includes both short-term and long-term sources of funds.

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