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Business Analysis : Sourcing And Managing Funds

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Sourcing and Managing Funds
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I. Leverage: It is the firm’s ability to use fixed cost funds against variable cost funds to increase the value of the firm and returns there by. Leverage is of 2types:-
1) Operating Leverage- It is determined by dividing the firms sales revenue by its EBIT (earnings before interest and taxes).
2) Financial Leverage- It represent the relationship between EBIT and PAT i.e. EBIT/earning available by ordinary share holders.

II. Capital structure theories-

1) Net income approach- According to this approach the cost of debt and the cost of equity remain unchanged when that equity ratio varies. Therefore WACC declines with an increase in that equity ratio. In this approach it is consider that the debt and…show more content…
They had following assumption;
A) A perfect capital market
B) No asymmetric information
C) No transaction cost
D) No bankruptcy cost
E) Security are infinitely divisible
F) Managers at in the interest of shareholders
G) Firms can be grouped into risk classes
H) No tax
In their 1st proposition they considered that the firm’s value is not depending on its capital structure. The 2nd proposition held that financial leverage incrrases to expected EPS keeping the share price constantly. The 3rd proposition concluded that an investment finance by common stock is advantageous to the outstanding shareholders only in the case that it yield exceed the capitalization rate.
5) Trade Off Theory- In this theory management running firms evaluate the various cost and benefits of alternative leverage plans and strives to bring a trade of between them. Often it is assumed that an interior solution is obtained so that marginal cost and marginal benefits are balanced. This theory implied that company capital structure decision involves a trade of between the tax benefit of debt and the cost of financial distress. Trade of theories consists of following variants:
A) Static trade of theory
B) Dynamic trade of theory

6) Bankruptcy cost theory- Expected bankruptcy cost depends on the cost of bankruptcy and the probability of occurrence. Increase the debt financing will increase the probability of bankruptcy and will in
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