4 Explain the factors affecting Capital Structure. Solve the below given problem: Given below are two firms, A and B, which are identical in all aspects except the degree of leverage, employed by them. What is the average cost of capital of both firms? Details of Firms A and B Firm A Firm B Net operating income EBIT Rs. 1, 00, 000 Rs. 1, 00, 000 Interest on debentures I Nil Rs.25,000 Equity earnings E Rs.1,00,000 Rs.75,000 Cost of equity Ke 15% 15% Cost of debentures Kd 10% 10% Market value of equity S = E/Ke Rs. 6, 66, 667 Rs.5,00,000 Market value of debt B Nil Rs.2,50,000 Total value of firm V Rs. 6, 66, 667 Rs,7,50,000 Explanation of factors affecting capital structure Solution for the problem Interpretation
Answer: Factors Affecting Capital Structure
Leverage: The use of sources of funds that have a fixed cost attached to them, such as preference shares, loans from banks and financial institutions, and debentures in the capital structure, is known as “trading on equity” or “
