## Capital Structure — Meaning & Determinants
Capital structure refers to the combination (mix) of capital raised from different sources of long-term finance. The capital of a company consists of:
- Equity Shareholders' Funds (equity share capital + reserves/retained earnings)
- Preference Share Capital
- Long-Term External Debt (debentures, long-term loans)
### What a Capital Structure Decision Involves
The decision answers three linked questions:
1. Forms of financing — which sources to tap?
2. Actual requirement — how much amount to fund?
3. Relative proportion (mix) — in what ratio in total capitalisation?
### The Three Guiding Factors
The source and quantum of capital is decided keeping three factors in mind:
| Factor | What it requires |
|---|---|
| Control | Structure should let existing shareholders retain a majority stake |
| Risk | Financial risk should not rise beyond a tolerable limit |
| Cost | Overall cost of capital (K₀) should be kept at a minimum |
> Key tension: It is practically difficult to achieve all three goals together. A finance manager must therefore strike a balance among Control, Risk and Cost.
### The Overarching Objective
While balancing the above, the prime objective in deciding the optimal capital structure is to maximise the value of the company (value of the firm).
### Map of the Chapter
The chapter can be broadly studied in four parts:
1. EBIT–EPS Indifference Point
2. Break-Even Points
3. EBIT–EPS–MPS Analysis
4. Capital Structure Theories