What is the Capital structure? Explain any five factors affecting the choice of capital structure?
Or
Describe the factors that determine the capital structure of a company.
Or
The Board of Directors has asked you to design the capital structure of the company. Explain any six factors that you would consider while doing so.
Or
“Determination of the capital structure of a company is influenced by a number of factors”. Explain any four such factors.
Or
State any four factors affecting the choice of capital structure.
Capital structure refers to mix sources of long-term finance. Sources of finance include
Share Capital Borrowed fund and Retained earnings. The appropriate proportion of funds is made in such a manner that it can give more benefit or return to the shareholders.
Some of the chief factors affecting the choice of the capital structure are the following:
- Cash Flow Position: While making a choice of the capital structure, the future cash flow position should be kept in mind. Debt capital should be used only if the cash flow position is really good because a lot of cash is needed in order to make payment of interest and refund of capital.
- Interest Coverage Ratio ICR: With the help of this ratio, an effort is made to find out how many times is the Earning Before Interest and Tax (EBIT) available to the payment of interest. The capacity of the company to use debt capital will be in direct proportion to this ratio. This ratio can be found out with the help of the following formula:
ICR = EBIT/Interest - Debt Service Coverage Ratio (DSCR): This ratio removes the weakness of ICR. This shows the cash flow position of the company.
- Return on Investment (ROI): If the RoI of the company is higher, it can choose to use trading on equity to increase its EPS, i.e., its ability to use debt is greater.
- Cost of Debt: The capacity of a company to take debt depends on the cost of debt. In case the rate of interest on the debt capital is less, more debt capital can be utilized and vice-versa.
