Which of the following pairs of a factor affecting the financing decision and its description is correctly matched?
Answer & explanation
Correct answer: option 3
The correct answer is Option (3) → Cost – A prudent financial manager would normally opt for a source which is the cheapest.
Option (1) Floatation costs – A stronger cash flow position may make debt financing more viable than funding through equity. — Incorrect. This line describes the cash flow position of the company. Floatation cost is the cost of raising the funds. The higher it is, the less attractive the source.
Option (2) Control considerations – A depressed capital market may make the issue of equity shares difficult for any company. — Incorrect. This line describes the state of the capital market. Control considerations are about a fresh equity issue weakening the management’s hold on the business.
Option (3) Cost – A prudent financial manager would normally opt for a source which is the cheapest. — Correct. Each source of funds has a different cost. A careful manager picks the cheapest source.
Option (4) Fixed operating costs – Companies afraid of a takeover bid would prefer debt to equity. — Incorrect. Fear of a takeover is a control consideration. Fixed operating costs are costs like rent, insurance and salaries. When they are high, the firm should use less debt.
NCERT (2026-27 Edition): “Factors Affecting Financing Decisions The financing decisions are affected by various factors. Important among them are as follows:” “(a) Cost: The cost of raising funds through different sources are different. A prudent financial manager would normally opt for a source which is the cheapest.” “(b) Risk: The risk associated with each of the sources is different.” “(c) Floatation Costs: Higher the floatation cost, less attractive the source.” “(d) Cash Flow Position of the Company: A stronger cash flow position may make debt financing more viable than funding through equity.” “(e) Fixed Operating Costs: If a business has high fixed operating costs (e.g., building rent, Insurance premium, Salaries, etc.), It must reduce fixed financing costs. Hence, lower debt financing is better. Similarly, if fixed operating cost is less, more of debt financing may be preferred.” “(f) Control Considerations: Issues of more equity may lead to dilution of management’s control over the business. Debt financing has no such implication. Companies afraid of a takeover bid would prefer debt to equity.” “(g) State of Capital Market: Health of the capital market may also affect the choice of source of fund. During the period when stock market is rising, more people invest in equity. However, depressed capital market may make issue of equity shares difficult for any company.” |