Identify the factor which does not affect the choice of capital structure of a company?
Answer & explanation
Correct answer: option 3
The correct answer is Option (3) → Diversification
Capital structure is the mix of owners’ funds (equity) and borrowed funds (debt).
Option (1) Cash flow position — Affects capital structure (Incorrect). A strong cash flow lets the company pay interest on time, so it can use more debt.
Option (2) Floatation Costs — Affects capital structure (Incorrect). The cost of raising funds (for example, a public issue of shares) affects the choice between debt and equity.
Option (3) Diversification — Does not affect capital structure (Correct). It is a factor of fixed capital: when a firm starts a new line of business, its need for fixed capital increases.
Option (4) Cost of Equity — Affects capital structure (Incorrect). Shareholders expect a higher return when the company takes more debt, so this limits the use of debt.
NCERT (2026-27 Edition): “6. Diversification: A firm may choose to diversify its operations for various reasons, With diversification, fixed capital requirements increase e.g., a textile company is diversifying and starting a cement manufacturing plant. Obviously, its investment in fixed capital will increase.” “1. Cash Flow Position: Size of projected cash flows must be considered before borrowing. …” “7. Cost of Equity: … It is for this reason that a company can not use debt beyond a point. …” “8. Floatation Costs: … These considerations may also affect the choice between debt and equity and hence the capital structure.” |