Match List-I (factors affecting the choice of capital structure) with List-II (what the factor says):
| List-I | List-II | ||
|---|---|---|---|
| (A) | Cash flow position | (I) | In a bullish phase, equity shares are more easily sold, even at a higher price. |
| (B) | Tax rate | (II) | Projected receipts must cover fixed payment obligations, with a sufficient buffer, before borrowing. |
| (C) | Risk consideration | (III) | Because interest is a deductible expense, debt becomes relatively cheaper than equity. |
| (D) | Stock market conditions | (IV) | A firm with lower fixed operating costs has a higher capacity to use debt. |
Choose the correct answer from the options given below:
Answer & explanation
Correct answer: option 2
The correct answer is Option (2) → (A)-(II), (B)-(III), (C)-(IV), (D)-(I)
| List-I | List-II | Reason |
|---|---|---|
| (A) Cash flow position | (II) Projected receipts must cover fixed payment obligations, with a sufficient buffer, before borrowing. | Debt brings fixed payments of interest and principal. Projected cash flows must cover these payments and still leave a buffer. |
| (B) Tax rate | (III) Because interest is a deductible expense, debt becomes relatively cheaper than equity. | Interest is deducted before tax is worked out. So a higher tax rate makes debt cheaper after tax. |
| (C) Risk consideration | (IV) A firm with lower fixed operating costs has a higher capacity to use debt. | Business risk depends on fixed operating costs. When business risk is lower, the firm can carry more debt. |
| (D) Stock market conditions | (I) In a bullish phase, equity shares are more easily sold, even at a higher price. | In a rising market, equity shares sell easily and at good prices. So firms prefer equity in a bullish phase and may turn to debt in a bearish one. |
NCERT (2026-27 Edition): “1. Cash Flow Position: Size of projected cash flows must be considered before borrowing. Cash flows must not only cover fixed cash payment obligations but there must be sufficient buffer also. It must be kept in mind that a company has cash payment obligations for (i) normal business operations; (ii) for investment in fixed assets; and (iii) for meeting the debt service commitments i.e., payment of interest and repayment of principal.” “6. Tax Rate: Since interest is a deductible expense, cost of debt is affected by the tax rate. The firms in our examples are borrowing @ 10%. Since the tax rate is 30%, the after tax cost of debt is only 7%. A higher tax rate, thus, makes debt relatively cheaper and increases its attraction vis-à-vis equity.” “9. Risk Consideration: As discussed earlier, use of debt increases the financial risk of a business. Financial risk refers to a position when a company is unable to meet its fixed financial charges namely interest payment, preference dividend and repayment obligations. Apart from the financial risk, every business has some operating risk (also called business risk). Business risk depends upon fixed operating costs. Higher fixed operating costs result in higher business risk and vice-versa. The total risk depends upon both the business risk and the financial risk. If a firm’s business risk is lower, its capacity to use debt is higher and vice-versa.” “13. Stock Market Conditions: If the stock markets are bullish, equity shares are more easily sold even at a higher price. Use of equity is often preferred by companies in such a situation. However, during a bearish phase, a company, may find raising of equity capital more difficult and it may opt for debt. Thus, stock market conditions often affect the choice between the two.” |