You are a financial consultant for a company that has a very high capital base but low earnings per share (EPS). EXPLAIN over-capitalization. What…

Over-capitalization and its Causes and Consequences It is a situation where a firm has more capital than it needs or in other words assets are worth less than its issued share capital, and earnings are insufficient to pay dividend and interest. Causes of Over Capitalization Over-capitalisation arises due to following reasons: Raising more money through issue of shares or debentures than company can employ profitably.Borrowing huge amount at higher rate than rate at which company can earn.Excessive payment for the acquisition of fictitious assets such as goodwill etc.Improper provision for depreciation, replacement of assets and distribution of dividends at a higher rate.Wrong estimation of earnings and capitalization. Consequences of Over-Capitalisation Over-capitalisation results in the following consequences: Considerable reduction in the rate of dividend and interest payments.Reduction in the market price of shares.Resorting to “window dressing”.Some companies may opt for reorganization. However, sometimes the matter gets worse and the company may go into liquidation.