Under cash flow position as a factor affecting the choice of capital structure, a company has cash payment obligations for normal business operations, for investment in fixed assets, and for:
Answer & explanation
Correct answer: option 3
The correct answer is Option (3) → meeting the debt service commitments
Option (1) payment of dividend to equity shareholders — Incorrect. A company is not bound to pay any dividend on equity shares. So dividend is not a fixed cash obligation.
Option (2) building up reserves and surplus — Incorrect. Reserves are profits kept back in the business. Keeping them is a choice. It is not a payment the company owes anyone.
Option (3) meeting the debt service commitments — Correct. Debt service means paying interest and repaying the principal. These are fixed payments the company must make. So its cash flows must cover them, with some buffer, before it borrows more.
Option (4) meeting the floatation costs of new issues — Incorrect. Floatation cost is the cost of raising funds, such as the expenses of a public issue. It is a separate factor in the choice of capital structure.
NCERT (2026-27 Edition): “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.” |