1 Capital Structure – Financing Decision – Financial Management ~ B.COM / BBA / CMA

In this video I have explained the concept of Capital Structure and format of EBIT – EPS (Earning Per Share) Analysis.

Hi everyone in this video we are going to start this new chapter of financial management that is financing decisions right now this chapter finance and decision it’s a very simple chapter because here we have problems on ebit analysis right a bit eps mps analysis and we have got problems on leverages ok financial leverage operating leverage and combined leverage

It’s very simple we are going to see how to solve these problems in the coming videos fine but in this video what are we going to do is in this video we are going to see the introduction of this chapter and we are going to see what is meant by financing decisions and what is meant by capital structure and all right so let’s start now first let’s understand what is

The meaning of financing decisions right see financing decision means it is a decision which is concerned with the amount of finance to be raised from various long-term sources of funds what i said it is concerned with how the finance will be raised in the business right from where from various long-term sources of funds now you will see what our various long-term

Sources of funds yeah we understood that it is concerned with raising of finance in business but long term sources of funds what are those what are long-term sources of funds see long term sources of funds means debt right equity and preference that means debentures or bonds equity means equity shares preference mean preferences the company can raise the finance by

Issuing the ventures by issuing bonds by what by issuing equity shares or by issuing preferences yes and what the company pays in return in return on debentures the company pays interest on equity the company pays dividend and on preference the company pays fixed dividend isn’t it it pays fixed amount of dividend in preference shares fine so these are the different

Sources of long-term funds and in this chapter in financing decisions when we talk about funds we mean long-term funds okay we are not talking about short-term funds like bank loan non we are talking about long-term funds that are debt equity and preference fine so financing decision means it is a decision which is concerned with the amount of finance to be raised

From various long-term sources of funds fine so in financing position these questions come into the mind of a finance manager that how much finance is needed for the business to achieve its goals right let’s say 10 lakh capital is needed then like finance is needed for business ok so now from various such finance can be procured this question also comes into the

Mind of finance manager from where does the business will get the fine and that 10 like finance there are three different sources of funds right debt equity and preference isn’t it the business can issue the company can issue equity shares preference shares and debentures yes and the third question is and in what proportion and in what proportion in what proportion

Means that in what ratio how much now you need 10 lakh right that in this example which we took just now that we need 10 lakh and we have got three sources debt equity and preference yeah and in what proportion in what ratio in what percentage from dead you can raise the entire finance also 10 lakh entirely from debt or 10 like entirely from equity or 10 lakhs

Entirely from reference so that also you can do or what you can do is you can take mix of these sources for example you can take 20 percent from debt 80 percent from equity or let’s say 50 percent from equity 20 percent from debt and then 30% from preference the finance manager can do anything right but will that be fine just doing anything no of course not why

Because this is financial management this is a finance manager we are talking about we are not doing lottery over here okay we’ll take it said we will take 20 percent from there and 30 percent for me could like that you can’t do that we have to base our financing decisions on some analysis rather we have to use some tools financial tools some financial or you say

Financial tools to do analysis and find out the best option right the best proportion in which the business will benefit the most right the owners of the business that equity shareholders will benefit the most that is what we have to see in this chapter okay we have to see the point of view of equity shareholders the real owners of the business the real owners of

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The company right so that is what so here financing decision means it is concerned with the raising of finance from long term sources of funds right and the most important thing is in what proportion how much will you raise from each of these sources that is the most important thing in this fine so we will see all that with an example later right so there’s one more

Thing that is capital structure that is very important capital structure now what is meant by capital structure see here we have definition of this author see capital structure of a company refers to the composition or makeup of its capitalization and it includes all long-term capital resources the simple meaning of capital structure it’s it’s just a composition

Of capital it’s just what composition i will show you here see this is the capital structure of certain business okay see you dimensions 15% preference 25% equity 60-person you see this composition this much is equity this much is the bench or this much is preference this is the basically what is meant by this is basically what is meant by capital structure the

Composition of capital the composition or makeup how the makeup is of capitalization right this is the basic concept of capital structure right so capital structure is what see this simple meaning capital structure is the combination right the combination combination of capitals from different sources of finance right these are different source debentures from debt

Preference from preference and equity right there are different sources of funds right different of funds and is a combination of capital that’s all it’s very simple the capital stock to the console you understood right it’s just what it’s just a composition it’s just a mix of capitals or a blend of capitals right blender blend of capitals mix of capitals make up

Of capitals composition of capital that’s it it’s very simple capital structure it’s just the structure of capital okay but here what are we talking about is how to raise the finance and how to choose our capital structure the finance manager has to choose the best capital structure the best proportion in what proportion he has to make up the capitalization that

Is what we learn in this chapter financing decision okay so let’s take an example in their example we will understand the whole concept of this chapter right let’s do this okay let’s understand the financing decision chapter in proper detail now let’s take an example to understand more about the capital structure and the concept of this financing decision right

So let’s see this is you right and you are a finance manager of this company and this company wants to get a capital of 30 groups it is in need of 30 groups now tell me how are you going to raise the finance how are you going to raise the 30 rows see the first thing that you do is you need to identify the sources the long-term sources of funds right there are

Equity shares debt or debentures prefectures right so now you have to create a capital structure you have to create a capital structure so let’s say you came up with the four options the first option that came into your mind was equity shares only you will raise the entire 30k rule from equity shares by issuing equity shares and then the second option that came

To your mind was equity and preferences let’s say you will use 70% equity and 30% preferences okay and then the third option was equity and debentures okay equal to 60 and dementia 40 person if it is for example and then the fourth option that came into your mind was equity shares preference shares and debentures the whole mix okay so you see this what is capital

Structure produced or it is nothing mix mix of capitals composition of capitals blend of capital and right right this is the capital structure how the capital is made up of that is the capital structure these are the options you have or he can create more options also only debentures you can do that right bart tell me how will you choose the best capital structure

In these four how will you do that you will do that on the basis of some evidence on the basis of some tools on the basis of some analysis you will base your decision you will not take that act leave your decision you’re a finance manager you can’t do that you can’t just take lottery you can just take out check and say okay i will choose option three you can’t do

That you have to base your decisions on some analysis so that is exactly what you are going to do to choose the best capital structure or i can say the optimum capital structure to choose the best capital structure the optimum capital structure and among this for what you need to do is you need to analyze you need to calculate the cost of capital in each of these

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Options and you have to choose the option which has the minimum cost of capital the minimum cost of capital and which has maximum earning per ship maximum earning per share okay equity share i’m talking about earning per share or market price per share fine so you have to calculate eps earning per share and cost of capital to find out the best option now this we

Will see that in this another chapter that is cost of capital chapter okay here we just do a bit analysis to find out the eps okay we just do this eps ebit analysis a bit eps analysis and calculate the eps at the end or if possible we calculate the mps but mostly in the be combi be a and bbm exams they will give own little eps okay you don’t have to calculate mps

But still i have given you just for in case alright right so we will see that now so we will see this format now okay so what i said was choose the optimum capital structure what did you do you need to select the option which has the minimum cost of capital and which has the maximum value of the firm which means maximization of equity shareholders wealth there is

The objective of financial management right the primary objective of financial management maximizing the wealth of equity shareholders that means maximizing the earning per share maximizing the earning porsha i have directly taken over here see maximizing earning power maximum earning portion the option which will give you the maximum earning per share the highest

Earning per share that option you have to go for that option you have to choose as your capital structure of your company fine you got the idea this is how you are going to choose your capital structure the option which has the maximum earning per share eps and the minimum cost of capital that option you are going to choose fine so this is how and this is a format

Here i have the format of eps okay ebit eps like this you will calculate the eps understood so now we will discuss the format now so you understood that example right and you got the idea right about the capital structure it is just a mix and you have to choose one option among the option given to you in the question okay how will you do that you will do the evil

Eps analysis of each options and you will calculate the eps of each options and select the highest eps option understood so that’s all you have to do in this chapter and then we will see the leverages in the in the third video right in the second video we will solve the problem of ebit ebs so first let us see the format of this right let’s discuss the format now

Here is the format of ebit eps analysis see here see if you can see over here first we have got sales minus variable cost right which will give us contribution and then contribution minus fixed cost will give us earning before interest and tax yes must see this part right from sales to fixed cost this part is meant for leverage problems because in eps and this

Capital structure problems in this ebit analysis problems here here the e bit will be given to you and they will say choose the best capital structure right which option will you go for right they will ask that in the cushion so if it will be given to you in the problem itself in the question itself in the leverage problems leverage the operating leverage combine

Leverage and financial leverage this will not be given to you you have to calculate you have to start from sales right but in this this will be given to you so you will directly start from ebit directly start from a bit okay this part is excluded from sales to fixed cost this part is excluded okay here you will directly start from ebit so earning before interest

And tax so here you see here a bit ebit right first what do you have i so first you will deduct the interest interest on the venture okay you will deduct the interest and then you will arrive at if you remove the i right what you will get evd earning before tax right you will get earning before tax fine after deducting the interest on debentures what you will

Get earning before tax simple right and then you will remove the t you will remove the tax earning before tax minus tax then what you will get from before it will become after each earning after tax understood earning before tax – tax you will get earning after tax simple first what you did subtract i interest then whatever you get from that subtract t right then

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It will be eat ringing after tax and then if there are preference shares deduct a dividend preference dividend it will be fixed dividend the person they should be given to you preference dividend subtract that then you will arrive at earning available to ei earning available to equity shareholders okay burning available to equity shareholders understood learning

Available to equity shareholders you will arrive at eh okay and then divide that years turning available to equity shareholders by number of equity ships divide that by number of equity shares then you will get eps earning per ship fine mostly become in become exam vba exams mostly you just have to calculate the eps but if they have given p/e ratio then you have

To multiply eps with p/e ratio and go to mps and then compare the mps with each of these mps okay mps or the first option and peers of the second option and peers of the third option and mps of the fourth option what i’m trying to say is you have to do this on the columnar basis if you have four options then 1 column 2 column 3 column 4 column so you have to use

4 column like that okay and you have to compare the mps the option which has the highest mps among these four option right or whatever options that are given to you in the exam you have to compare them and the highest option will be selected the option which has the highest mps or eps depending upon the question you have to select that option understood and now

You will see why did we do this see we needed eps what is the formula of eps it’s the simple thing eps formula is earning available to equity shareholders divided by number of equity ships right so you need erling available to only equity shareholders so that is why you have to remove interest you have to remove the government tax you have to remove the preference

Dividend and then whatever money is left that is available for equity shareholders only then you will be able to calculate eps right so you have to go on deducting all that one by one first i then t then dividend right then you will get ish earning available to equity shareholders divided by number of equity shares you will get earning per share fine and then you

Can also find easily mps how why did i multiply p/e ratio with eps 2 final mps see it’s very simple first let’s see the p ratio formula price-earning ratio right p ratio means price-earning ratio it is a ratio of price over earning right so pricey means what market price and an earning means earning per share so pe ratio is equal to m ps by eps but if we have p

Ratio and if we have eps yeah the pv ratio will be given to you in the question and we have calculated the eps then easily you can calculate m ps how is that you can just cross multiply see right you have to calculate m ps right this multiply it is with p ratio just multiply right so np s will be equal to e ps into p ratio ups into p ratio right so you directly

Will get the mps understood so this is how if you have got a ps and b ratio then do calculate the mps and then compare the mps with all the options okay compare the mps of all the option and then choose the option which has the highest mps if you can calculate mps otherwise go for abs mostly in the become problem in the exams they will conclude the problems in

Eps the price an englisher will not be given to you in the question if price-earning ratio is not given then you cannot calculate mps till here only your problem will be finished understood so this is how you have to do the ebit analysis understood so this is how you will calculate the best option right the option which has the maximum eps or mps and minimum cost

Of capital we will see this in the cost of capital chapter okay how to calculate the cost of capital don’t worry in the next video we are going to solve one problem on ebit eps analysis and then we’ll go on we will move on to the leverages problems fine we’ll see combined leverage of financial leverage and operating in pitch okay easy right all right

Transcribed from video
#1 Capital Structure – Financing Decision – Financial Management ~ B.COM / BBA / CMA By Saheb AcademyliveBroadcastDetails{isLiveNowfalsestartTimestamp2019-10-17T161303+0000endTimestamp2019-10-17T163420+0000}