Page 185 - DMGT207_MANAGEMENT_OF_FINANCES

Management of Finances

Notes For example during 2003 to 2004 period, many firms like Vijaya Bank, IOB, Union Bank,
TCS, IOC, NTPC come up with IPO due to ideal capital market and the economy. Prices as
well as yields on securities depend on the money policy pursued by the government.
Scarcity of debt money and equity funds leads to high interest rates and low price earnings
(P/E) ratios. Therefore, company has to decide whether to finance infancy stage with
equity funds and latter stages (except declining) with debt funds or vice versa.
11. Requirements of Investors: Before going to issue a particular instrument to the public or
investors to raise funds, there is a need to know the investors requirements. Investors may
be institutional investors. (LIC, GIC, UTI) as well as individual investors. Some investors
are ready to take risk (bold investors.), who prefer capital gains and control and hence,
equity shares are suitable to them. On the other hand, investors. (cautious), who are
interested in the safety of their investment and stable returns, prefer to invest in debentures,
since satisfying their needs and preference share are more suitable to the investors. (less
cautious), who prefers stable returns and share in profits.
12. Period of Finance: Period of finance also plays a crucial role in determining the capital
structure. A firm can issue redeemable debentures or preference shares, when the finance
is required for a limited period. For example, for 5 years, firm can issue 5 years redeemable
debentures or preference shares. But equity share capital is the best source when the firm
needs finance for unlimited period (unknown).
13. Purpose of Finance: Debt source of finance is suitable when a firm is planning to invest in
productive (avenues) purpose. For example, investment on machinery, where as, if the
firm is planning to raise funds for non-productive purpose, it can raise funds from equity
source for example social responsibility or general development on a permanent basis.
14. Legal Requirements: There are some guidelines on shares and debentures issued by the
government that are very important for the construction of the capital structure. For
example, the controller of capital issues, now SEBI grants to consent for capital issue when,
(a) debt equity ratio does not exceed 2 : 1 (higher ratio may be allowed for capital intensive
projects), (b) the ratio of preference capital to equity capital does not exceed 1 : 3 and
(c) promoters hold at least 2.5 per cent of the equity capital.

Did u know? Patterns/Forms of Capital Structure
The following are the forms of capital structure.
1. Complete equity share capital;
2. Different proportions of equity and preference share capital;
3. Different proportions of equity and debenture (debt) capital; and

4. Different proportions of equity, preference and debenture (debt) capital.

8.6 Assumption of Capital Structure Theories

1. There are only two sources of funds i .e. debt and equity.
2. The total assets of the company are given and do not change.

3. The total financing remains constant. The firm can change the degree of leverage, either
by selling the shares and retiring debt or by issuing debt and redeeming equity.
4. Operating profits (EBIT) are not expected to grow.

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