Time Vaue of Maoney
MODULE 5: CAPITAL STRUCTURE & COST OF CAPITAL
After studying this module, you should be able to: 1. Define the overall cost of capital 2. Calculate the cost of individual components of a firms’ overall cost of capital, cost of debt, cost of preferred stock and cost of equity 3. Calculate the firm WACC 4. Be able to define the term capital structure. 5. Explain the traditional approach to capital structure and the valuation of a firm. 6. Discuss the relationship between leverage and the cost of capital as originally set forth by Modigliani and Miller
CAPITAL STRUCTURE
Capital Structure concern with the right hand side of the balance sheet. It is the collection of securities a firm issues to raise capital from investors. There are only two ways in which a business can make money ( raise capital) a) Debt financing. The essence of debt is that you promise to make fixed payment in the future (interest payments and repaying principal). If you fail to make those payments, you lose control of your business. b) Equity financing. With equity, you do get whatever cash flows are left over after you have made debt payments In other words, capital structure is the mix of the long term sources of funds used by the firm. It is the relationship between debt and equity capital. This is also called the firm’s capitalization. It is a proportion of firm’s permanent long-term financing represented by debt, preferred stock, and common stock equity. Capital structure is different from financial structure which is the mix of all items that appear on the right-hand side of the company’s balance sheet. The relationship between financial and capital structures can be expressed in equation form: Prepared by:Rahayu Abdull Razak Page 1
Financial Structure – Current liabilities = Capital Structure A firm’s financial structure is often described by the debt ratio.
Financial leverage The relationship between the two sources of finance, debt and equity, gives measures of the gearing of
After studying this module, you should be able to: 1. Define the overall cost of capital 2. Calculate the cost of individual components of a firms’ overall cost of capital, cost of debt, cost of preferred stock and cost of equity 3. Calculate the firm WACC 4. Be able to define the term capital structure. 5. Explain the traditional approach to capital structure and the valuation of a firm. 6. Discuss the relationship between leverage and the cost of capital as originally set forth by Modigliani and Miller
CAPITAL STRUCTURE
Capital Structure concern with the right hand side of the balance sheet. It is the collection of securities a firm issues to raise capital from investors. There are only two ways in which a business can make money ( raise capital) a) Debt financing. The essence of debt is that you promise to make fixed payment in the future (interest payments and repaying principal). If you fail to make those payments, you lose control of your business. b) Equity financing. With equity, you do get whatever cash flows are left over after you have made debt payments In other words, capital structure is the mix of the long term sources of funds used by the firm. It is the relationship between debt and equity capital. This is also called the firm’s capitalization. It is a proportion of firm’s permanent long-term financing represented by debt, preferred stock, and common stock equity. Capital structure is different from financial structure which is the mix of all items that appear on the right-hand side of the company’s balance sheet. The relationship between financial and capital structures can be expressed in equation form: Prepared by:Rahayu Abdull Razak Page 1
Financial Structure – Current liabilities = Capital Structure A firm’s financial structure is often described by the debt ratio.
Financial leverage The relationship between the two sources of finance, debt and equity, gives measures of the gearing of