Given below are two statements:
Statement I: A weaker cash flow position may make debt financing more viable than funding through equity.
Statement II: A company planning to raise debt must have sufficient cash to meet the increased outflows because of higher debt.
In the light of the above statements, choose the correct answer from the options given below:
Answer & explanation
Correct answer: option 4
The correct answer is Option (4) → Statement I is incorrect but Statement II is correct.
Statement I: A weaker cash flow position may make debt financing more viable than funding through equity. — Incorrect. Debt needs regular payment of interest and principal. Only a company with a stronger cash flow position can meet these payments safely. A weak cash flow makes debt risky.
Statement II: A company planning to raise debt must have sufficient cash to meet the increased outflows because of higher debt. — Correct. Interest and repayment of principal are obligatory. So a company that borrows more must have enough cash for the higher outflows.
NCERT (2026-27 Edition): “(d) Cash Flow Position of the Company: A stronger cash flow position may make debt financing more viable than funding through equity.” “Factors affecting the Choice of Capital Structure … Interest payment and repayment of principal are obligatory on a business. In addition a company planning to raise debt must have sufficient cash to meet the increased outflows because of higher debt. Similarly, important factors which determine the choice of capital structure are as follows:” “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.” |