risk(1) (1)
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Transcript of risk(1) (1)
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A way a corporation fnances itsel throughsome combination o equity and debt.
The capital structure should be designedwith the aim o maximizing the marketvaluation o the frm in the long run.
Capital Structure
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MARKET RISK The possibility of loss to a bank/firm/company due to
change in market variables
Market Risk is also referred to as systematic risk or
non-diversifiable risk
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The possibility for an investor to experience losses
due to factors that affect the overall performance of
the financial markets
The risk that a major natural disaster will cause a
decline in the market as a whole is an example of
market risk. ther sources of market risk
include recessions! political turmoil! changes in
interest rates and terrorist attacks.
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The possibility that a company will have lower than
anticipated profits! or that it will experience a loss rather
than a profit.
"usiness risk is influenced by numerous factors! including
sales volume! per-unit price! input costs! competition!
overall economic climate and government regulations.
# company with a higher business risk should choose a
capital structure that has a lower debt ratio to ensure that
it can meet its financial obligations at all times.
BUSINESS RISK
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"usiness risks can major by the influence by two major
risks$ internal risks %risks arising from the events
taking place within the organi&ation' and external
risks %risks arising from the events taking place outside
the organi&ation'.
(nternal risks arise from factors such as human factors
%talent management! strikes'! technological factors%emerging technologies'! physical factors %failure of
machines! fire or theft'! operational factors %access to
credit! cost cutting! advertisement'.
)xternal risks arise from factors such as economicfactors %market risks! pricing pressure'! natural factors
%floods! earth*uakes'! political factors %compliance and
regulations of government'
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The possibility that shareholders will lose money when
they invest in a company that has debt! if the
company+s cash flow proves inade*uate to meet its
financial obligations.
,inancial Risk as the term suggests is the risk that
involves financial loss to firms.
,inancial risk generally arises due to instability and
losses in the financial market caused by movements instock prices! currencies! interest rates and more.
FINANCIAL RISK
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Business Risk )xcluding debt! business risk is the basic risk of the company+s operations. The
greater the business risk! the lower the optimal debt ratio.
Companys Tax Exposure
ebt payments are tax deductible. #s such! if a company+s tax rate is high!
using debt as a means of financing a project is attractive because the taxdeductibility of the debt payments protects some income from taxes.
Financial Flexi!ility
This is essentially the firm+s ability to raise capital in bad times. (t should come
as no surprise that companies typically have no problem raising capital when
sales are growing and earnings are strong. owever! given a company+s strong
cash flow in the good times! raising capital is not as hard. ompanies should
make an effort to be prudent when raising capital in the good times! not
stretching its capabilities too far. The lower a company+s debt level! the more
financial flexibility a company has.
"eterminats o# Capital Structure
"ecisions
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Mana$ement Style Management styles range from aggressive to conservative. The more conservative a
management+s approach is! the less inclined it is to use debt to increase profits. #n
aggressive management may try to grow the firm *uickly! using significant amounts of
debt to ramp up the growth of the company+s earnings per share %)01'.
%ro&t' Rate
,irms that are in the growth stage of their cycle typically finance that growth throughdebt! borrowing money to grow faster. The conflict that arises with this method is that the
revenues of growth firms are typically unstable and unproven. #s such! a high debt load
is usually not appropriate.
Market Con(itions
Market conditions can have a significant impact on a company+s capital-structure
condition. 1uppose a firm needs to borrow funds for a new plant. (f the market isstruggling! meaning investors are limiting companies+ access to capital because of market
concerns! the interest rate to borrow may be higher than a company would want to pay. (n
that situation! it may be prudent for a company to wait until market conditions return to a
more normal state before the company tries to access funds for the plant.
"eterminats o# Capital Structure
"ecisions
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)"(T-)01 #2#341(1
R)-R( #2#341(1
)*+ T* ESTIMATE TAR%ET CA,ITAL
STRUCTURE
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(t helps to understand what should be the optimum
capital structure which could generate highest )01. (t
would help in determining what should be the direct
ideal combination of debt-e*uity capital structure.
(t can be well explain with the help of break-even
point %indifference point'.(t refers to the )"(T level
at which the )01 remains same for two differentfinancial plans.
EBIT-E,S ANAL.SIS
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#t break even point we can calculate the )"(T 5 )01 by
using the formula
%)"(T-('%6-t' 7 %)"(T-('%6-t'
2 2
EBIT-E,S ANAL.SIS
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M#T)M#T(#334 #3>3#T) #1 ,33:
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THANK YOU