Fundamentals of Financial Management, Third Edition

SUMMARY

Capitalisation, which denotes the amount of long-term and short-term capital employed in a firm, is an important issue involved in the financing decision. It is true that the amount of capital is determined on the basis of the cost of various assets, but at the same time, the amount of capital must justify the earnings of the firm. In case the magnitude of capital exceeds this limit so that a part of capital remains unemployed, the return on investment falls below the normal rate in the industry and the firm is said to be over-capitalised. This is often caused by factors that cause inflation of the book value of assets on the one hand, and shrinkage in the earnings, on the other. However, this lowers the value of the corporate wealth, ...