Which among the following is not a factor affecting the choice of capital structure?
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → Fixed costs
Option (1) Fixed costs — Not a determinant of capital structure (Correct). The list of factors that decide the capital structure does not name fixed costs as a factor of its own.
Option (2) Floatation costs — A factor affecting the choice (Incorrect). A public issue of shares or debentures costs a great deal to make. A loan from a financial institution may cost far less. That difference pushes the firm towards one source rather than the other.
Option (3) Cost of Equity — A factor affecting the choice (Incorrect). As the firm borrows more, the risk carried by the shareholders rises. They then expect a higher return. Beyond a point this cost rises so steeply that the firm stops borrowing.
Option (4) Interest coverage ratio — A factor affecting the choice (Incorrect). It shows how many times the firm’s earnings cover its interest. A high ratio means the firm can safely take more debt. A low ratio is a warning against borrowing.
Note: The factors that govern the choice of capital structure are a fixed list: cash flow position, interest coverage ratio, debt service coverage ratio, return on investment, cost of debt, tax rate, cost of equity, floatation costs, risk consideration, flexibility, control, regulatory framework, stock market conditions and the capital structure of other companies. Fixed operating costs do affect operating or business risk under the wider financing decision. But “fixed costs” on its own is not one of the listed factors. Floatation costs, cost of equity and the interest coverage ratio, on the other hand, are all named factors. NCERT (2026-27 Edition): “Factors affecting the Choice of Capital Structure … Similarly, important factors which determine the choice of capital structure are as follows:” “2. 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. …” “7. Cost of Equity: Stock owners expect a rate of return from the equity which is commensurate with the risk they are assuming. …” “8. Floatation Costs: Process of raising resources also involves some cost. …” |