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1. Introduction The cost of capital, as a decision criterion, is an overall or combined cost, representing the composite cost of various sources of financing. Measuring it involves two key steps: Specific Costs: Calculating the cost of each individual source...

1. Introduction Companies raise debt through various channels, including financial institutions, public deposits, and debentures (bonds). The interest rate and the conditions of issue (par, discount, or premium) directly affect the cost of this debt. This docu...

1. Introduction The cost of preference shares represents the return expected by investors who hold these securities. While it's not a legally binding obligation like debt interest, firms typically prioritize paying preference dividends. Understanding the cost ...

1. Introduction The cost of equity capital is the return that a company must provide to its equity shareholders. It is a critical factor in determining the overall cost of capital and making investment decisions. Equity shareholders invest with an expectation ...

1. Introduction Retained earnings, the portion of a company's profits not distributed as dividends, represent an internal source of financing for investment proposals. Unlike debt, preference shares, and external equity, retained earnings do not involve a form...

1. Introduction The overall cost of capital (WACC) is a composite or average cost, derived by combining the costs of individual sources of financing, weighted by their proportions in the company's capital structure. It is used as a hurdle rate for investment a...

What is Capital Structure? Capital structure refers to how a company finances its assets, specifically the proportions of: Debt: Money borrowed (e.g., loans, bonds). Equity: Money from owners (e.g., common shares, retained earnings). Optimum Capital St...

The Net Income (NI) Approach, proposed by Durand, suggests that a company's capital structure (the mix of debt and equity) significantly impacts its valuation. This means that changing the amount of debt a company uses (financial leverage) will affect the over...

The Net Operating Income (NOI) Approach, also suggested by Durand, presents a contrasting view to the NI Approach. It argues that a company's capital structure is irrelevant to its overall value. In simpler terms, changing the amount of debt a company uses wil...

The Traditional Approach to capital structure sits between the two extremes of the Net Income (NI) and Net Operating Income (NOI) approaches. It acknowledges that a company's capital structure (mix of debt and equity) does affect its value and cost of capital,...

The Modigliani-Miller (MM) approach provides a fundamental framework for understanding how capital structure impacts firm value. It challenges conventional wisdom and offers insights into the trade-offs involved in financing decisions. It provides 3 propositio...

Determining the "optimal" capital structure (the ideal mix of debt and equity financing) is a complex process that requires understanding different theories and considering the specific circumstances of a company. There's no one-size-fits-all solution, but by ...

Leverage is a financial strategy where a company uses fixed costs to potentially amplify returns for its shareholders. These fixed costs can stem from operations (like rent) or financing (like debt interest). The basic concept: Leverage: Using assets or fund...

Operating leverage arises when a company has fixed operating expenses that remain constant regardless of sales volume. It essentially amplifies the impact of changes in sales on a company's earnings before interest and taxes (EBIT), also known as operating pro...

Financial leverage focuses on how a company's financing decisions impact its earnings available to shareholders. It arises from the use of fixed financial charges in the firm's income stream, such as interest payments on debt or preferred dividends. Core Conce...

EBIT-EPS analysis is a tool to help companies compare different financing options (equity, debt, preference shares) and their impact on earnings per share (EPS) under various EBIT scenarios. The goal is to identify the financing plan that maximizes EPS for the...

Combined leverage examines the total effect of both operating and financial leverage on a company's risk and potential returns. It provides a comprehensive view of how changes in sales translate into changes in earnings per share (EPS). Core Concepts Operati...

Distributing Profits vs. Reinvesting in the Business Dividends represent a portion of a company's net earnings that are paid out to its shareholders. This section focuses on dividends paid to ordinary shareholders in widely-held public companies. Core Concepts...

Balancing Profits and Shareholder Value A company's dividend policy – the decisions it makes about how much of its earnings to distribute to shareholders versus retain for reinvestment – is influenced by a variety of factors. Here's a breakdown of key consider...

Dividend Policy Theories: Relevance vs. Irrelevance The impact of dividend policy on a firm's valuation is a topic of ongoing debate. This section explores two contrasting viewpoints: those who believe dividends are relevant and those who argue they are irrele...