An important function of financial management is to decide an appropriate capital structure of their company. The financial performance of a company depends upon the capital structure decisions. A good capital structure will help the company to increase profits, efficiency and reputation of the company. Therefore, capital structure decisions are very important. An appropriate capital structure can be determined on the basis of the following factors: (1) TRADING ON EQUITY: Trading on equity means use of owned capital as well as borrowed capital in the capital structure of a company. A company can raise funds by issue of shares and debentures. Debentures carry a fixed rate of interest and the interest is paid irrespective of profits. A company can also raise capital only by issue of shares. In this case, the shareholders will get less amount of dividend because of large number of shareholders. However, if a company issues shares as well as debentures, the shareholders will be benefited more in the form of dividend. Debenture holders have a limited share in the company's profits and hence want to be protected in terms of earnings and values represented by equity t50 capital. Fixed interest on debt does not vary with the firms' earnings before interest and tax, a magnified effect is produced on earnings per share. Illustration 1: A Ltd wants to raise Rs. 1, 00,000 as capital. The company expects earnings before interest and taxes (EBIT) Rs. 40,000 per annum. The management is considering the following alternatives for raising the capital: (a) Issue 10,000 equity shares of Rs. 10 each. (b) Issue 5000 equity shares of Rs. 10 each and 500, 12% preference shares of Rs. 100 each. (c) Issue 5000 equity shares of Rs. 10 each and 10 % Debentures of Rs. 50,000. You are required to calculate earnings per share and advise the alternative to be used for raising capital, assuming tax rate of 30%