Financial Management

Subrata Halder Theory of Capital Structures

1


Value of Firm (V) = S + B
S = Value of Equity Share Capital
B = Value of Debt/Bond
Ke = Cost of Equity Share
= Equity Capitalization Rate
Kd = Cost of Debt
= Debt Capitalization Rate
= Interest Rate
Ko = Overall Cost of Capital
= Overall Capitalization Rate
= Weighted Average Cost of Capital
= WACC
-------------------------------------------------------------
EBIT = Earning Before Interest & Tax
NI = Net Income = EACS [No Tax]
EAT = Earning After Tax
= EACS
= Earning Available to Common Stockholders
EPS = Earning Per Share
DPS = Dividend Per Share
DFL = Degree of Financial Leverage
INT = Interest
Tr = Tax Rate (Corporate)
Tp = Personal Tax Rate
-------------------------------------------------------------
Vu = Value of Unlevered Firm
Vl = Value of Levered Firm
Keu = Equity Capitalization Rate of Unlevered Firm
Kel = Equity Capitalization Rate of Levered Firm
Kou = Keu = Overall Capitalization Rate of Ul firm
Kol =Overall Capitalization Rate of Levered Firm
Su = Market Value of Equity Shares of Ul Firm
Sl = Market Value of Equity Shares of Levered Firm
NI & NOI Approach:
>> V = S + B
=

MM, No Tax:
>> Vu = Vl =

MM, With Tax:
>> Vu =
(1)

>> Vl = Vu + TB
=
(1)

+ ( BTr)


NI & NOI Approach:
>> S =

= V- B
= No of Shares Unit Share Price
>> B =
()
()

= V S
MM, No Tax & With Tax:
>> Su = Vu
>> Sl = Vl - B

NI & NOI Approach :
>> Ke = Ko + (Ko Kd)

100
MM Approach:
>> Keu =

100 [No Tax & With Tax]

[ Note: When Tax isnt available, Keu = Kou. But,
when Tax is available, Keu Kou]
>> Kel = Keu + (Keu Kd)

[ No Tax]
= Kou + ( Kou Kd)

[ No Tax]
>> Kel = Keu + (Keu Kd)

(1-Tr) [Tax]
= Kou + (Kou Kd)

(1-Tr) [Tax]

Financial Management

Subrata Halder Theory of Capital Structures
2


When Personal Tax is Available :
Vu =
(1)(1)

Vl = Vu + [1 -
(1)(1)
(1)
]B
= Vu + [1 -
(1)(1)
(1)
]B Reduction in B
Added Value / Gain From Leverage / Tax Shield:
= Vl Vu = [1 -
(1)(1)
(1)
]D

For WACC method:
We =

= Equity Weight
Wd =

= Debt Weight
WACC = Ko =

Kd +

Ke
= (WdKd + WeKe)

NI & NOI Approach:
>> Ko =

100
=

Kd +

Ke
= Ke - (Ke Kd)

MM Approach:
>> Kou = Keu [No Tax]
>> Kou =

Kd +

Keu [ With Tax]

>> Kol =

Kel +

Keu [No Tax]

>> Kol =

Kd (1-Tr) +

Kel [Tax]
Others:
EPS = DPS =

DFL =

PFL =

100
Market Price Per Share =

Tabular Format (NI Approach)
Particulars Taka
EBIT ***
Less : Interest ***
NI ***
Ke ***
S = (

) = (

) ***
B ***
V= S + B
***

Ko = =

100 ***

Arbitrage Process ( From Levered To Unlevered)
Investors Position
In L Firm
Taka
Position In U Firm
After Arbitrage
Taka
Share Capital







Income From
Dividend
***







***
Sales of Share
Personal Leverage
Fund Available

Investment
>>Investment Savings

Income From Divided
Less: Interest
***
***
***

***
***

***
***
Net Income From
Arbitrage Process
***
Net Income From
Arbitrage Process
***
Arbitrage Process ( From Unlevered To Levered)
Investors
Position In U
Firm
Taka
Position In L Firm
After Arbitrage
Taka
Share Capital







Income From
Dividend
***







***
Sales of Share
Fund Available

Investment:
In Shares
In Debt
Total Investment

>>Investment Savings

Income From Divided
Income From Interest
***
***


***
***
***

***

***
***
Net Income
From Arbitrage
Process
***
Net Income From
Arbitrage Process
***