Question

Explain the following factors affecting choice of capital structure of a company: (i) Return on Investment (ii) Floatation Costs (iii) Flexibility OR…

Accepted Answer

(i) Return on Investment Return on Investments an important determinant of the  company’s ability to use Trading on equity in the capital structure. If the ROI of the company is higher, it can choose to use  trading on equity to increase its earning per share i.e., its ability to use more debt in its capital structure. (ii) Floatation Costs  Process of raising resources like shares and debentures from public issue involves some cost. 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. (iii) Flexibility  While deciding a capital structure, if a firm uses its debt potential to the full, it loses its flexibility to issue further debt.  To maintain flexibility, it must maintain some borrowing power to take care of unforeseen circumstances. OR (b) Explain the following factors affecting working capital requirement of a company: (i) Nature of business (ii) Business cycle (iii) Inflation (i) Nature of business  A trading organisation usually needs a smaller amount of working capital compared to a manufacturing organisation. This is because there is usually no processing.  Service industry require less working capital. (ii) Business Cycle  In case of a boom, the sales as well as production are likely to be larger and, therefore, larger amount of working capital is required.  As against this, the requirement for working capital will be lower during the period of depression as the sales as well as production will be small. (iii) Inflation  The working capital requirement of a business becomes higher with higher rate of inflation.  The actual requirement shall depend upon the rates of price change of different components (e.g. raw material, finished goods, labour cost).

Explain the following factors affecting choice of capital structure of
a company :
(i)
Return on Investment
(ii)
Floatation Costs
(iii)
Flexibility

Marking-scheme solution

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(a)OR(b)Explain the following factors affecting choice of capital structure ofa company :(i)Return on Investment(ii)Floatation Costs(iii)FlexibilityExplain the following factors affecting working capital requirementof a company :(i)Nature of business(ii)Business cycle(iii)Inflation

Marking-scheme solution

More from Financial Management

Explain the following factors affecting choice of capital structure of
a company :
(i)
Return on Investment
(ii)
Floatation Costs
(iii)
Flexibility