Question

Explain the following as factors affecting the choice of capital structure:
(i)Cash flow position
(ii)Cost of equity
(iii)Floatation costs
(iv)Stock-market conditions

Answer 1

Capital structure refers to the proportion of debt and equity held by a company.

(i)Cash flow position: The cash flow position should be such that a company must be able to fulfill its cash obligations and is also left with some buffer. The capital structure of the company should be decided taking this factors into consideration.

(ii)Cost of equity: Higher the cost of equity , in terms of divided payments,lower is its proportion in the total capital and vice-verse.

(iii) Floatation cost: Costs involved in raising funds from various sources affect the choices of the capital structure by a company.Higher the costs related to public issue of shares or debentures, higher is the use of debts rather than equity.

(iv)Stock-market conditions: Favourable stock market conditions makes equity more attractive, increasing its proportion in the total capital and vice-versa.