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    MBA Assignment

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    Simran Vishwakarma
    Overcapitalization occurs when a company raises more capital than needed, which is unhealthy and inefficient. As a result, the company's market value falls below its capitalized worth, forcing it to pay high interest and dividends that are unsustainable long-term. This signifies poor capital management and inefficient use of funds. Undercapitalization is the opposite, where a company's real value exceeds its book value due to underestimating earnings, unforeseen increases in earnings, conservative dividend policies, or high operational efficiency. Both situations have negative effects such as lower share prices and returns, inadequate capital structures, and underutilization of resources.

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    MBA Assignment

    Uploaded by

    Simran Vishwakarma
    11 views3 pages
    Overcapitalization occurs when a company raises more capital than needed, which is unhealthy and inefficient. As a result, the company's market value falls below its capitalized worth, forcing it to pay high interest and dividends that are unsustainable long-term. This signifies poor capital management and inefficient use of funds. Undercapitalization is the opposite, where a company's real value exceeds its book value due to underestimating earnings, unforeseen increases in earnings, conservative dividend policies, or high operational efficiency. Both situations have negative effects such as lower share prices and returns, inadequate capital structures, and underutilization of resources.

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    Overcapitalization occurs when a company raises more capital than needed, which is unhealthy and inefficient. As a result, the company's market value falls below its capitalized worth, forcing it to pay high interest and dividends that are unsustainable long-term. This signifies poor capital management and inefficient use of funds. Undercapitalization is the opposite, where a company's real value exceeds its book value due to underestimating earnings, unforeseen increases in earnings, conservative dividend policies, or high operational efficiency. Both situations have negative effects such as lower share prices and returns, inadequate capital structures, and underutilization of resources.

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    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    11 views3 pages

    MBA Assignment

    Uploaded by

    Simran Vishwakarma
    Overcapitalization occurs when a company raises more capital than needed, which is unhealthy and inefficient. As a result, the company's market value falls below its capitalized worth, forcing it to pay high interest and dividends that are unsustainable long-term. This signifies poor capital management and inefficient use of funds. Undercapitalization is the opposite, where a company's real value exceeds its book value due to underestimating earnings, unforeseen increases in earnings, conservative dividend policies, or high operational efficiency. Both situations have negative effects such as lower share prices and returns, inadequate capital structures, and underutilization of resources.

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    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
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    Over Capitalization

    Overcapitalization is when a firm has raised capital over a particular limit, which
    is inherently unhealthy for the company. As a result, its market value is less than
    its capitalized worth. In this case, the company ends up paying more interest
    and dividends, which is impossible to sustain in the long term. It simply signifies
    that the company is not using the fund efficiently and has poor capital
    management.
    Effects of over capitalisation:
    Over-capitalisation affects the company, the shareholders and the society as a
    whole. The confidence of Investors in an over-capitalised company is injured on
    account of its reduced earning capacity and the market price of the shares which
    falls consequently. The credit-standing of a corporation is relatively poor.
    Consequently, the credit-standing of a corporation is relatively poor.
    Consequently, the company may be forced to incur unwieldy debts and bear the
    heavy loss of its goodwill In a subsequent reorganization. The Shareholders bear
    the brunt of over capitalization doubly. Not only is their capital depreciated but
    the income is also uncertain and mostly irregular. Their holdings have little value
    as collateral security.
    An over-capitalised company tries to increase the prices and reduce the quality
    of products, and as a result such a company may liquidate. In that case the
    creditors and the Labourers will be affected. Thus, it leads to the mis-application
    and wastage of the resources of society.
    Advantages
    • The company has excess capital or cash on the balance sheet, which they can
    put in the bank and earn a nominal rate of return, strengthening their
    liquidity position.
    • It results in a higher valuation of the company, which means that the
    company, in case of an acquisition or a merger, can get a higher price for
    itself as it can take excess capital and cash on its balance sheet
    • Overcapitalization can fuel and fund the Capex plans of the company.
    Disadvantages
    • The rate of return on capital goes down as the company raises more and
    more capital from the market, making the company’s capital structure look
    bad and inadequate.
    • The shareholder’s confidence in the company gets lost because of the
    underutilization of funds, resulting in a fall in the share price.
    • It creates problems with re-organization.
    • It leads to the underutilization of available resources.
    • It also leads to a higher rate of taxation on the company’s income statement
    • The company cannot easily market its shares. Thus, it can lead to
    malpractices, often associated with manipulating its earnings period or the
    earnings amount. It also leads to a superior valuation of assets than its real
    value or intrinsic value.

    Under capitalization
    Generally, under-capitalization is regarded equivalent to the inadequacy of
    capital but it should be considered as the reverse of over-capitalization i.e. it is
    a condition when the real value of the corporation is more than the book value.
    The following are the causes for under-capitalization:
    1. Underestimation of earnings:
    Sometimes while drafting the financial plan, the earnings are anticipated at a
    lower figure and the capitalisation may be based on that estimate; if the
    earnings prove to be higher the concern shall become under-capitalised.
    2. Unforeseeable increase in earnings:
    Many corporations started during depression find themselves to be under-
    capitalised in the period of recovery or boom due to unforeseeable increase in
    earnings.
    3. Conservative dividend policy:
    By following conservative dividend policy some corporations create adequate
    reserves for depreciation, renewals and replacements and plough back the
    earnings which increase the real value of the shares of those corporations.
    4. High efficiency maintained:
    By adopting ‘latest techniques of production many companies improve their
    efficiency. The profits being dependent on the efficiency of the concern will
    increase and, accordingly, the real value of the corporation may exceed its ‘book
    value’.
    Effects of under-capitalisation:
    The following are the effects of under-capitalisation:
    1. Causes wide fluctuations in the market value of shares.
    2. Provoke the management to create secret reserves.

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