Which of the following factor affects Choice of Capital Structure?

A. Interest Coverage Ratio
B. Working capital
C. Floatation Costs
D. Tax Rate
E. Cost of debt

Choose the correct answer from the options given below.

A, C, D and E only

The correct answer is option 4- A, C, D and E only.

Except working capital, all other factor affects Choice of Capital Structure of a company.

Interest Coverage Ratio (ICR): The interest coverage ratio refers to the number of times earnings before interest and taxes of a company covers the interest obligation. This may be calculated as follows:
EBIT/ Interest. The higher the ratio, lower shall be the risk of company failing to meet its interest payment obligations. However, this ratio is not an adequate measure. A firm may have a high EBIT but low cash balance. Apart from interest, repayment obligations are also relevant.

Cost of debt: A firm’s ability to borrow at a lower rate increases its capacity to employ higher debt. Thus, more debt can be used if debt can be raised at a lower rate.

Tax Rate: Since interest is a deductible expense, cost of debt is affected by the tax rate. A higher tax rate makes debt relatively cheaper and increases its attraction for equity under favorable condition.

Floatation Costs: Process of raising resources also involves some cost. Public issue of shares and debentures requires considerable expenditure. Getting a loan from a financial institution may not cost so much. These considerations may also affect the choice between debt and equity and hence the capital structure.