The factors affecting choice of capital structure are:
(A) Cash flow position
(B) Tax Rate
(C) Nature of Business
(D) Cost of debt
Choose the correct answer from the options given below:
Answer & explanation
Correct answer: option 1
The correct answer is option 1- (A), (B) and (D) only.
Except (C) Nature of Business, all other factor affect choice of capital structure. Nature of business affect fixed capital requirements.
Nature of Business: The type of business has a bearing upon the fixed capital requirements. For example, a trading concern needs lower investment in fixed assets compared with a manufacturing organisation; since it does not require to purchase plant and machinery, etc
OTHER OPTIONS
- 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.
- Cost of debt: A firm’s ability to borrow at a lower rate increases its capacity to employ higher debt. Thus, more debt can be used if debt can be raised at a lower rate.
- Tax Rate: Since interest is a deductible expense, cost of debt is affected by the tax rate. A higher tax rate, thus, makes debt relatively cheaper and increases its attraction vis-à-vis equity.