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356 Corporate Finance BRILLIANT’S

investors and lenders. Hence, beyond a point, gmW BÝdoñQ>g© H$s Ano{jV [aQ>Z© H$s Xa ^r ~‹T>Zo bJVr
cost of capital begins to rise. This point indicates h¡Ÿ& Bgr {~ÝXw H$mo AmXe© H¡${nQ>b ñQ´>ŠMa H$hm OmVm h¡Ÿ&
the optimal capital structure. Modigliani and _mo{X½bmZr-{_ba Ho$ AZwgma, `{X H$a H$mo Ü`mZ _| Zht
Miller argued that in the absence of corporate
income taxes, cost of capital is independent of the aIm Om`o Vmo H¡${nQ>b ñQ´>ŠMa H$m H$m°ñQ> Am°’$ H¡${nQ>b na
capital structure of the firm. H$moB© à^md Zht n‹S>VmŸ&
However, it may be concluded that de- Cnamoº$ {ddaU Ho$ AmYma na `h H$hm Om gH$Vm h¡
spite the correctness of the basic reasoning of {H$ `Ú{n _mo{X½bmZr-{_ba H$s AdYmaUm VH©$nyU© h¡, {H$ÝVw
Modigliani and Miller hypothesis, it is obvious
that due to tax effect, the cost of debt is lower H$a Ho$ à^md Ho$ H$maU F$U na ã`mO H$s Xa, Bp³dQ>r na
than the cost of equity capital. Hence, the tra- [aQ>Z© H$s Xa go h_oem H$_ hr hmoVr h¡Ÿ& Bg{b`o H¡${nQ>b
ditional approach has validity while forming {_lU H$s naånamJV AdYmaUm A{YH$ VH©$nyU© àVrV
capital mix. The basic assumptions in the hmoVr h¡Ÿ& gmW hr _mo{X½bmZr-{_ba H$s `h _mÝ`Vm {H$
Modigliani and Miller hypothesis regarding
the perfection of the capital market is seldom H¡${nQ>b ‘mH}$Q> na\o$ŠQ> AWm©V² nyU© hmoVm h¡, `h ^r
true. ì`mdhm[aH$Vm _| AË`§V H${R>Z h¡Ÿ& 

Q.38. Enumerate some other capital structure theories. Explain them in brief.
Hw$N> Aݶ H¡${nQ>b ñQ´>³Ma ϶moarO H$m dU©Z H$s{OE& CÝh| g§jon ‘| g‘PmB¶o&
Some more capital structure theories are Hw$N> Aݶ H¡¡${nQ>b ñQ´>³Ma ϶moarO {ZåZ{b{IV h¢…
as under:
1. Trading on equity 1. B{³dQ>r na Q´>oqS>J
The basic assumption relating to financial ’$m¶Z|{e¶b brdaoO go g§~§{YV ‘yb YmaUm h¡ {H$
leverage is that the firm can earn more on g§ñWm CYma ’§$S²>g na n«má g§n{Îm¶m| go A{YH$ H$‘m gH$Vr
assets acquired by the borrowed funds. Since h¡& My§{H$ CYma {b¶o J¶o ’§$S²>g H$mo ã¶mO Ho$ ê$n ‘| {ZpíMV
borrowed funds require a fixed payment in the
form of interest the difference between the ^wJVmZ Amdí¶H$ hmoVm h¡ Omo g§n{Îm¶m| go A{Zª½g VWm
earnings from the assets and interest on the B{³dQ>r eo¶ahmoëS>g© H$mo OmZo dmbo ’§$S²>g Ho$ Cn¶moJ na
use of the funds goes to the equity shareholders. ã¶mO Ho$ ~rM A§Va h¡&
Hence, use of fixed interest bearing funds AV…, {ZpíMV ã¶mO Ho$ ’§$S²>g ‘| eo¶ahmoëS>g© go
provides increased return on equity ’§$S²>g H$s A{V[a³V Amdí¶H$Vm Ho$ {~Zm B{³dQ>r B§doñQ>‘|Q>
investment without additional requirement of
funds from the shareholders. Trading on equity na [aQ>Z© ~‹T>Vm h¡& B{³dQ>r na Q´>oqS>J EH$ à{Vð>mZ Ho$
refers to the utilization of non-equity sources H¡${nQ>b ñQ´>³Ma ‘| ’§$S²>g Ho$ Zm°Z-B{³dQ>r gmog}g Ho$ Cn¶moJ
of funds in the capital structure of an H$m g§X^© XoVm h¡&
enterprise.
The use of borrowings for the purpose of ao{gS²>¶wAb ñQ>m°H$hmoëS>g© Ho$ {bE ’$m¶Z|{e¶b
financial advantage for residual stockholders ES>dm§Q>oO Ho$ CÔoí¶ Ho$ {b¶o CYma H$m Cn¶moJ B{³dQ>r
is called trading on equity. Hence, trading on na Q´>oqS>J H$hbmVm h¡& AV…, B{³dQ>r na Q´>oqS>J ~m§S²>g,
equity may be based upon bonds, non- Zm°Z-nm{Q>©{gnoqQ>J {à’$S>© ñQ>m°H$ VWm/¶m gr{‘V a|Q>b
participating preferred stock and/or limited brOog na AmYm[aV hmo gH$Vm h¡& O~ EH$ H$m°nm}aoeZ