“Determining the relative proportion of various types of funds depends upon various factors”. Explain any five such factors.

Or

“Determining the overall cost of capital and the financial risk of the enterprise depends upon various factors”. Explain any five such factors.

The following factors affect the financing decision:

(i) Cost: The cost of all the sources of finance is different. The rate of interest on debt, fixed rate of dividend to be paid on preference share capital and the expectations of the shareholders on the equity share capital are in the form of costs. If the situations happen to be favourable, the benefit of cheap finance can be availed of by choosing debt capital. (ii) Risk: Debt capital is most risky and from the point of view of risk it should not be used.

(iii) Floatation Cost: From the point of view of floating costs, retained profit is the most appropriate source. Therefore, its use should be made.

(iv) Cash Flow Position: If the cash flow position of the company is good, the payment of interest on the debt and the refund of capital can be easily made. Therefore, in order to take advantage of cheap finance, debt capital can be given priority.

(v) Level of Fixed Operating Costs: In business, there are mainly two types of costs:

(a) Fixed Operating Costs, e.g., rent of the building, payment of salary, insurance premium, etc.

(b) Fixed Financial Costs, e.g., interest on debt, etc.

If the level of fixed operating costs is in excess, it is better to keep the fixed financial costs at their minimum. Therefore, debt capital should not be used. On the contrary, if the level of fixed operating cost is low, the use of debt capital is profitable.