The factors influencing pattern on capital structure are as follows −EconomyIndustryCompanyEconomyMeasure of economy: Equity is preferred.Capital market: Funds availability depends on the market conditions.Taxation: Varies with different tax structures.Policy of financial institutions: Choosing of debt may change with change in policy.IndustryFrequent variations: Frequent variations in activities may lead to bankruptcy over the years.Competition: Risk factor has to be kept in mind to get profits between competitors.Phase in industry cycle: Source of funds changes with change in phase in industry cycle.CompanyType of company (small, medium, large): Availability of funds depend on type of company.Structure of organization: Flexibility between equity and debt ... Read More

Finance manager has to decide the right combination of capital based on certain principles and available source of funds to maximize returns. Guiding principles of capital structure are as follows −Cost principleRisk principleControl principleFlexibility principleTiming principleCost principle −Main concern of this principle is to earn maximum Earnings per share with minimum cost of financing.Interest rates and tax rates controls cost of financing.Debt capital is cheaper.Risk principleMain concern of this principle is that it will not accept stiff risks.High rates on debts than earnings may lead liquidity trap.Declaration of dividends is voluntary.Encourages equity and limits debt as a source of funds.Control ... Read More

SolutionThe solution is as follows −Cost of debt=(Interest+(redemptionvalueofdebenture–issueprice)/maturityyear)(1−taxrate)(redemptionvalueofdebenture+issueprice)/2=(Interest+(redemptionvalueofdebenture–issueprice)/maturityyear)(1−taxrate)(redemptionvalueofdebenture+issueprice)/2Interest = 12 Redemption value = 110 Issue price = 80 Tax rate = 42% => 0.42 Maturity year = 2 yearsCost of debt ==(12+(110–80)/2)(1−0.42))(110+80)/2=(12+(110–80)/2)(1−0.42))(110+80)/2Cost of debt ==15.6695=15.6695Cost of debt = 16.48%Cost of preference capital=(dividendspershare+(netprice–(issueprice−floationcost)/redemptionperiod(netprice–(issueprice−fl

Sl. NoAccountsRefDebitCredit1Owners’ equity18002Owners’ drawings6003Equipment’s35004Sales34005Customers payment Dues6006Purchases15007Purchases returned5008Loan9709Creditors55010Taxes62011Cash in hand45012Note payable82313Inventory35014Repair42389667120SolutionThe solution is as follows −Sl. NoAccountsRefDebitCredit1Owners’ equity18002Owners’ drawings6003Equipment’s35004Sales34005Customers payment Dues6006Purchases15007Purchases returned5008Loan9709Creditors55010Taxes62011Cash in hand45012Note payable82313Inventory35014Repair423Total80438043

Breakeven point (BEP) is a point where, there is no loss or no gain to the company. It is a point where, company starts earnings profits. Net income or earnings per share is zero. Fixed is independent of volume of sales and variable cost is dependent on volume of sales.FormulaWe know, Net income = EBIT * (1-IE) * (1-TR) – PDAt breakeven point (EBIT), Net income = 00 = EBIT * (1-IE) * (1-TR) – PDEBIT = (PD/(1-TR))+ IEBEP (in units) = FC / (RPU-VCPU) (Accounting breakeven)BEP (sales in $) = FC / (SPPU*BEP in units)Here BEP = Breakeven point. ... Read More

SolutionThe solution is mentioned below −FVn = PV (1+r) ^nHere, PV = 5000, r =12%, n = 4 yearsFVn = 5000 (1+12%) ^4 FVn = 5000 (1.12) ^4 FVn = Rs. 7867.60/-b) Calculate the deposit after 12 years, if the investor deposited Rs. 80000 with 12% interest rate.FVn = PV (1+r) ^n FVn = 80000 (1+12%) ^12 FVn = 80000 (1.12) ^12 FVn = Rs. 311678.08/-c) An investor invested Rs. 15000 for 3 years with interest 14% compounded quarterly. Calculate Future value.FVn = PV (1+(r/m)) ^m*n FVn = 15000 (1+ (14%/4)) ^4*3 FVn = 15000 (1.035) ^12 FVn = Rs.22666.03/-d) ... Read More

If the interest is compounded, that means the interest which is earned at the end of year, will be added to principal and will go on till the end of time. Future values are calculated by using this compounding interest.As interest rates increases, compounding interest also increases, that means if you want large sum of money, interest rates must be high. So, when investors were investing, they should look for higher interest rate to get high returns in this method.Basic compounding problems includes −Future value of a single sum: compounds single amount to future valueFuture value of a series of ... Read More

The major differences between fixed interest rate and floating interest rate are as follows −Fixed interest rateInterest rates are high.Financial market conditions will have no effect on these rates.EMIs are fixed.By using these rates, it is possible to plan the budgets.It has sense of security.It is better for short or medium terms.On long term loans, it may have more impact on payments (if, increase in market).Less risk is involved.Floating interest rateInterest rates are low.Financial market conditions have effect on these rates.EMIs are not fixed, they change with interest rates.By using these rates, planning of budget is relatively difficultThese rates will ... Read More

The major differences between simple interest and compound interest are as follows −Simple interestIt is the percentage interest on total principal amount.Low returns.Principal is constant.Growth of both principal and interest is constant.Interest will be charged only on principal amount.Easy to calculate.Formula: PTR/100.Compound interestIt is the percentage interest charged on principal and accrued interest.High returns compared to simple interest.Both principal and accrued amounts changes because of addition of interest during the period.Principal and interest will grow at pace.Interest will be charged on both principal and interest.Difficult to calculate, when compared to simple interest.Formula = P(1+(r/100))^t – PRead More

The major differences between compounding and discounting techniques in time value of money are as follows −Compounding techniqueIt is a process of calculating future value using present investment.It determines money gained by an investment.It is also called as present value.Compound interest rate.Uses future value/compounding factor.Its formula is Fv= Pv(1+r)^nAmount increases in this method.Right side to left (time line).If the rate is low then, future value will decrease and if the rate is high then, future value will increase.Discounting techniqueIt calculates future cash flows using present value.It determines the amount to be invested to get maximum future gains.It is also called ... Read More