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
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
