Advantages of ordinary share capitalShareholders have the right to voteShareholders have the ability to elect the board of

directorsShareholders are able to buy as many new stocks as

possible

Disadvantages of ordinary shareShare prices fluctuate a lot, which short term oriented

investors find very distressing.Some companies go broke, and due to the occasional

dishonest auditor you won't be able to see it coming. Therefore you need to diversify a lot, though this is easy to do since you can buy small amounts of shares.

Shares require analysis and hard work if you are going to do better than average.

Advantages of preference share capitalPreference shares has no interference with the

management of the company.It makes the capital structure of a company to be flexible.Preference share has nothing to do with companies in the

mortgage of its asset.

Disadvantages of preference share capitalIt is a fixed burden on the company because company has

to pay dvident at fixed rate.Company pays tax on the dividend also after paying for

preference.

Advantages of Bonds and DebenturesDebenture holders have no right to participate in

management.Interest on debenture is deducted from the taxable income

of the company.Increase in debenture also increases the interest or income

of share holders.

Disadvantages of Bonds and Debentures Debenture interest and capital repayment are obligatory

payments.The protective covenants associated with a debenture

issue may be restrictive.Debenture financing enhances the financial risk

associated with the firm.

Advantages of long term debtThe cost is limited and known and cheaper than the cost

of equity (because it is less risky to the investor who therefore requires a lower required rate of return).

The interest is tax-deductible, unlike dividend payments, which makes the cost even cheaper in comparison to equity.

There is no dilution of control when debt is issued.

Disadvantages of long term debtThere is always the possibility of default if income is low.

The company must pay interest, even if it means taking out additional debt to do so.

The cost of equity rises as more debt is used. The higher leverage results in higher risk to shareholders who will require a higher rate of return.

Advantages of leasing financeLeasing better utilizes equipment; you lease and pay for

equipment only for the time you need it.There is typically an option to buy equipment at end of

lease term.You can keep upgrading; as new equipment becomes

available you can upgrade to the latest models each time your lease ends.

Typically, it is easier to obtain lease financing than loans from commercial lenders.

It offers potential tax benefits depending on how the lease is structured.

Disadvantages of leasing financeNo ownership: The main disadvantage of leasing is that

you never own the product.You have an obligation to continue making payments.

Typically, leases may not be terminated before the original term is completed.

You have no equity until you decide to purchase the equipment at the end of the lease term, at which point the equipment has depreciated significantly.

Cost of capital[WACC] weighted average cost of capital Cost of debts: cost of equity cost of preference shares:

Weight Average Cost of CapitalThe formula for the above measures= (Ke*E) + Ka(1-

t)*D/ E+ (D) = is the cost of the use of equity capital, provided by

the shareholders, and investors. (I) = is the cost of the use of debt capital provided by

capital lenders. The average between the rate of dividend and the rate if interest, is the average cost of capital.

Cost of DebtCost of debt, rd(I-T) , is also used to calculate (WACC) .Cost of debt is= interest rate on new debt- Tax savings = rd-rdT =rd(I-T)E.g. if allied can borrow at an interest rate of 10% and its

marginal federal plus-state tax rate is 40%, its cost of debt will be 6%.

Cost of debt is=rd I-T)=10%(1.0-0.4) =10% 0.6) =6.0%

Cost of preference sharecost of preference share = rp =DP/PpE.g allied sold some stock to a few large hedge fund, the

stock would have a $10.00 dividend per share and it will be priced at $97.50 a share. Thereby allied cost of preference stock would be $10.3%.

Rp = $10.00/$97.50 = 10.3%

Cost of CapitalMinimum required return / cost of capital= that

particulardiscount rate “k” that makes NPV = 0.! The return generated by a security is the cost of that

security to the company that issued it. cost of capital to the firm = reward to investors.! The cost of capital depends primarily on the use of

funds, i.e.,the risk of the CFs, not on the source.Q risk of CFs (systematic risk)Q company capital structure

Importance of cost of capital on capital structureCost of capital helps in making decision as to

whether or not to invest in productive asset such as plant, and machinery, coporate acquisition, working capital, and the like.

Cost of capital is also used to maximize the value of the existing share holder’ equity investment.

Cost of capital helps to accomplish the ends of net present value by accepting all project that are expected to be positive.

 Cost of capital helps to save high capital

value on financial decisions everyday.  

IMPORTANCE OF CAPITAL STRUCTURE 

It makes economic sense for the firm to strive to minimize the cost of using financial capital.

It is the basic point on consideration a trial capital structure, based on the market value of the debt and equity.

It helps to reduce accumulation of long term debt which affect the interest growth of an organization. 

It helps to maximize a firm’s common stock price.

Appraisal TechniqueOne of the most important steps in the

capital budgeting cycle is working out if the benefits of investing large capital sums outweigh the costs of these investments.

PAY BACK PERIOD(a)  It is so popular because of its simplicity.(b)  Payback takes account of the effect on

business profitability.(c)  It is the most objective method.

INTEREST RATE RETURN(a)  The amount of time it takes staff to repay

their training costs.(b)  The number of years to pay back an

original investment.(c)  The level of interest that a project is able

to withstand.

NET PRESENT VALUETime value. It recognizes the time value of

money-a $ received today is worth more than a $ received tomorrow.

Measure of true profitability. It uses all cash flows occurring over the entire life of the project in calculating its worth. Hence, it is a measure of the project’s true profitability.

Value additively. The discounting process facilitates measuring cash flows in terms of present values that is in terms of equivalent, current $.

Shareholder value. The net present value (NPV) method is always consistent with the objective of the shareholder value maximization. This is the greatest virtue of the method.

PROFITABILITY INDEXTime value. It recognizes the time value of

money.Value maximization. It is consistent with the

shareholder value maximization principle. A project with profitability index grater than one will have positive net present value (NPV) and if accepted, it will increase shareholders wealth.

Relative profitability. In the profitability index (PI) method, since the present value of cash inflows is divided by the initial cash outflow, it is a relative measure of a project’s profitability.