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“Our channel finance management and click on the bell icon to get update on new new videos. Today. We are going to study capital structure and its theories capital structure the proportion of all types of capital is equally debt preference etc. It is synonymously used as financial leverage or financing mix capital structure is also referred as the degree of debts in the financing or capital of a business firm financial leverage is the extent to which a business firm employs borrowed money or debts in financial management.
It is a significant term and an important decision in a business in the capital structure of a company broadly there are mainly two types of capital. That is equally and debt out of the two debt is considered a cheaper source of finance. Because the interest payments are a tax deductible expense capital structure or financial leverage deals with a very important financial management. Question.
The question is what should be the ratio of debt and equity before scratching our minds to find the answer to this question. We should know the objective of doing all this in the financial management context. The objective of any financial decision is to maximize the shareholders wealth or increase the value of the firm. The other question which hits the mind at the first place is whether a change in the financing mix would have any impact on the value of the firm or not the question is a valid question as there are some theories which believe that financial mix has an impact on the value and others believe it to be not connected how can financial leverage affect the value financial leverage can at the max have an impact on the net income or the eps earning per share.
The reason is explained further changing the financing mix means changing the level of debts and change in levels of debt can impact the interest payable by that firm decrease in interest would increase the net income and thereby the eps and it is a general belief that the increase in eps leads to increase in the value of the firm apparently under this view financial leverage is a useful tool to increase value. But at the same time nothing comes without a cost financial leverage increases the risk of bankruptcy. It is because higher the level of debt higher would be the fixed obligation to honor the interest payments to the debts. Providers.
Discussion of financial leverage has an obvious objective of finding an optimum capital structure leading to maximization of the value of the firm. Important theories or approaches to financial leverage or capital structure..
Or financing. Mix are as follows net income approach net operating income approach. Traditional approach. Modigliani and miller mm approach approach this approach was suggested by durant and he was in the favor of financial leverage decision.
According to him change in financial leverage would lead to a change in the cost of capital in short if the ratio of debt in the capital structure increases the weighted average cost of capital decreases and hence the value of the firm net operating income approach. This approach is also provided by durant. But it is totally opposite to the net income approach. It says that the weighted average cost of capital remains constant.
It believes in the fact that the market analyses firm as a whole which discounts at a particular rate. Which is not related to debt equity ratio. Traditional approach this approach is not to find hard and fast facts. But it says that cost of capital is a function of the capital structure.
The special thing about this approach is that it believes in optimal capital structure. Optimal capital structure. Implies that at a particular ratio of debt and equity. The cost of capital is minimum and value of the firm is maximum modigliani and miller approach.
It is a capital structure theory. Named after franco modigliani and merton miller mm theory proposed two propositions proposition..
One it says that the capital structure is irrelevant to the value of a firm. The value of two identical firms would be same and it would not be affected by the mode of finance adopted to finance. The assets the value of a firm is dependent on the expected future earnings proposition. Two it says that the financial leverage boosts the expected earnings.
But it does not increase the value of the firm because the increase in earnings is compensated by the change in the required rate of return. Thank you please subscribe like and when we get below 50 years of age. I m going to have a higher possibility of women being better rated on a mortality table. Not only because they really they don t they die.
Much more down the mortality line than males do but really the thing that really is remarkable here is more and more women that are under 50 have been really moving to good diet good exercise. Great lifestyle issues and we noticed that we have a lot of females that get the super preferred because they re really managing those issues and even preferred. Plus. Now that doesn t mean that males don t get it i m just saying that seems to be right now.
An inordinate number females have a very good chance of super preferred and remember this key issue when i talk about income later in our classes about a month from now. I m going to be looking at females who are super preferred because the cost of insurance is so low it makes my accumulating cash that much better so these are our five basic ideas of non rated. Now when i think about rated cases. There are 16.
Tables some people actually use the numbers and some people use the letters nobody that i m aware of today there s a few carriers out there but really fundamentally nobody s using table one or in letter ratings a it s pretty much been absorbed into the standard level. When i m looking at 16 tables that means that we re not declining a client..
All the way up to 16 tables so if i m at table. Let s say table. 4 for example. I might look at that table.
4. And say wow that s about 400 higher than the standard cost of insurance and as i move up the line. The number gets bigger. I ve also noticed that right around table two or table b in table two.
I ve noticed that some carriers will actually let you price off their standard. Plus. A couple of those carriers. Actually use their standard plus rating.
Not their standard rating for their table ratings. Which makes their numbers. A little bit more it will make it less expensive. And it really shaves off a good eight to ten percent on the actual premium.
So sometimes. When you re looking at table..
2. And you have a carrier that gives standard plus. They re gonna use the standard plus chassie not the standard chassis and that makes that premium lower and of course that makes it more competitive. Interesting to know talking about saving most table.
Shaving programs are right around table three and four four is probably the outside one that i ve seen where they re under certain circumstances. They carrier may take anything that s table four and there are some exceptions some cancers things of that nature and actually bring it down to standard and those are called table shaving programs programs that carriers deploy who they feel certain areas certain ages certain diseases that they can actually shave office. What would normally be a table rated case and shave it down to a standard case and this is really excellent and some of these most of the the market right now lets you shave. All the way up to age 70.
There s a few carriers out there that actually lets you shave up to 75. So this number is getting a little older. We re just dipping into the age 75 era and of course thus. Most of the market for shaving technology is sitting at seven.
But you could be sixteen tables and we re still writing it now you d have to look at the economic benefit is the premium cost at table. 16 good or bad. Now when i talk about it we ve just said we ve just talked about the word table rating and that s a percent generally of the standard mortality chassis and when i look at that percentage of my table rating. I can have a table rating.
I can also use another technology which we use in annuities ” ..
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