Arriving at capitalisation rate is equally a

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Arriving at capitalisation rate is equally a formidable task because the investors' perception of established companies cannot be really representative of what investors perceive of the earning power of new company. Table 1.3 Merits and demerits of earnings theory 1.7 Over-capitalisation A company is said to be overcapitalised, when its total capital exceeds the true value of its assets. The correct indicator of overcapitalisation is the earnings capacity of the firm. If the earnings of the firm are less then that of the market expectation, it will not be in position to pay dividends to its shareholders as per their expectations. It is a sign of overcapitalisation. Effects of over-capitalisation Decline in the earnings of the company Fall in dividend rates Market value of company's share falls, and company loses investors confidence Company may collapse at any time because of anemic financial conditions
7/ ADTU OLE Remedies for over-capitalisation Restructuring the firm is to be executed to avoid the situation of company becoming sick. It involves: Reduction of debt burden Negotiation with term lending institutions for reduction in interest obligation Redemption of preference shares through a scheme of capital reduction Reducing the face value and paid-up value of equity shares Initiating merger with well managed profit making companies interested in taking over ailing company 1.8 Under-capitalisation A company is considered to be under-capitalised when its actual capitalisation is lower than its proper capitalisation as warranted by its earning capacity. Causes of under-capitalisation Under estimation of future earnings at the time of promotion of the company Abnormal increase in earnings from new economic and business environment Under estimation of total funds requirements Maintaining very high efficiency through improved means of production of goods or rendering of services Use of low capitalisation rate Purchase of assets at exceptionally low prices during recession Effects of under-capitalisation Encouragement to competition It encourages the management of the company to manipulate the company's share prices Higher profits will attract higher amount of taxes Higher profits will make the workers demanding higher wages High margin of profit may create among consumers an impression that the company is charging high prices for its product Remedies Splitting up of the shares- This will reduce the dividend per share Issue of bonus share – This will reduce both the dividend per share and earnings per share.
Management Accounting 8/ ADTU OLE Summary The concept of financial management - is the operational activity of a business that is responsible for obtaining and effectively utilising the funds necessary for efficient operations Traditional and modern approach to financial management Goals of financial management- profit maximization and wealth maximization

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