Which of the following statements about the factors affecting the choice of capital structure is NOT correct?
Answer & explanation
Correct answer: option 4
The correct answer is Option (4) → Raising debt normally causes a dilution of the management’s control.
Option (1) A higher DSCR indicates a better ability to meet cash commitments. — True. DSCR compares cash profits with interest, preference dividend and repayments. A higher DSCR means the firm can meet its cash commitments more easily.
Option (2) If a firm uses its debt potential to the full, it loses flexibility to issue further debt. — True. This is the flexibility factor. A firm should keep some borrowing power in reserve for unforeseen needs.
Option (3) Getting a loan from a financial institution may cost less than a public issue of shares. — True. This is floatation cost. A public issue of shares needs considerable expenditure, while a loan from a financial institution may not cost so much.
Option (4) Raising debt normally causes a dilution of the management’s control. — False. Lenders get interest and repayment but no say in running the company. So debt normally does not cause a dilution of control. It is a public issue of equity that may cut the management’s holding.
NCERT (2026-27 Edition): “3. Debt Service Coverage Ratio (DSCR): … A higher DSCR indicates better ability to meet cash commitments and consequently, the company’s potential to increase debt component in its capital structure.” “8. 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.” “10. Flexibility: If a firm uses its debt potential to the full, it loses flexibility to issue further debt. To maintain flexibility, it must maintain some borrowing power to take care of unforeseen circumstances.” “11. Control: Debt normally does not cause a dilution of control. A public issue of equity may reduce the managements’ holding in the company and make it vulnerable to takeover. This factor also influences the choice between debt and equity especially in companies in which the current holding of management is on a lower side.” |