Consider the following statements about the factors affecting financing decisions:
(A) Higher the floatation cost of a source, less attractive the source.
(B) A stronger cash flow position may make funding through equity more viable than debt financing.
(C) A depressed capital market may make the issue of equity shares difficult for a company.
(D) If the fixed operating cost of a business is less, more of debt financing may be preferred.
Which of the statements given above are correct?
Choose the correct answer from the options given below:
Answer & explanation
Correct answer: option 3
The correct answer is Option (3) → (A), (C) and (D) only
(A) Higher the floatation cost of a source, less attractive the source. — Correct. Floatation cost is the cost of raising funds, such as issue expenses. The higher this cost, the less attractive the source.
(B) A stronger cash flow position may make funding through equity more viable than debt financing. — Incorrect. The two sources are switched. A stronger cash flow makes debt financing more viable than equity, because the firm can meet the interest and repayments.
(C) A depressed capital market may make the issue of equity shares difficult for a company. — Correct. When the stock market is down, fewer people invest in shares. So an issue of equity shares becomes difficult.
(D) If the fixed operating cost of a business is less, more of debt financing may be preferred. — Correct. Low fixed operating costs, such as rent and salaries, leave room for the fixed cost of debt. So the firm can take more debt safely.
NCERT (2026-27 Edition): “(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.” “(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.” |