It is also known as straight bankruptcy. The financial slack includes unused debt capacity, excess liquid assets, unutilised lines of credit and access to various untapped sources of funds.
Capital structure is influenced by the industry to which a company is related. Thus, from the viewpoint of flexibility to issue debt capital and preference share capital is the best.
When the theory is extended to include taxes and risky debt, things change. Similarly, it is compulsory for other companies to maintain a given debt-equity ratio while raising funds.
This then gives the outside investors an incentive to lower the value of the new equity. So in such conditions the company or firm would give preference to finance with debt till the higher earnings are materialized or reflected in the stock prices.
These firms also generate cash flow, which can be used to finance projects when they arise. Total capitalization amounts to be USDin each case. Floatation costs are those expenses which are incurred while issuing securities e.
If potential creditors sense that bankruptcy could be likely firms will have a harder time acquiring financing and even if they do, it will probably come at a high interest rate that significantly increases the cost of debt.
Therefore, trade off considerations change from firm to firm as they impact capital structure. It adversely affects the market value of the shares. Degree of control- In a company, it is the directors who are so called elected representatives of equity shareholders. If the management attitude is conservative it uses less debt, where if the management is having aggressive approach then it uses more debt to get higher profits.
This refers to the risk of inability to pay fixed financial payments e. These include commission of underwriters, brokerage, stationery expenses, etc. The weighted average cost of capital multiplies the cost of each security by the percentage of total capital taken up by the particular security, and then adds up the results from each security involved in the total capital of the company.
This means that a company stands committed to pay a higher amount of interest irrespective of the fact whether it has cash or not. Suppose a firm needs to borrow funds for a new plant.
A large company has relative flexibility in designing its capital structure. When a company issues further equity share it automatically dilutes the controlling interest of the present owners. Management may be conservatives or aggressive depending upon the attitude towards risk taking.
Bold and adventurous investors generally go for equity shares and loans and debentures are generally raised keeping into mind conscious investors. The total risk of business depends on both these types of risks. This ratio tells us about the cash payments to be made e.
According to this factor, at the time of preparing capital structure, it should be ensured that the control of the existing shareholders owners over the affairs of the company is not adversely affected.
But there are always some other factors which firms take into consideration while making capital structure decisions. Thus, there will be lower probability that equity shareholder will enjoy a stable dividend if the debt content is higher in the Capital Structure.
Borrowings carry a fixed rate of interest and this interest is payable irrespective of fact where there is profit or not. Interest on debentures has to be paid regardless of profit.
This factor may affect the capital structure decisions; there are two types of assets which are: Therefore, a capital structure should give enough choice to all kind of investors to invest. Thus, the form of debt a firm chooses can act as a signal of its need for external finance.
Therefore, a firm that is optimizing its overall value will focus on this trade-off when choosing how much debt and equity to use for financing. The tax advantage of debt implies that firms will employ more debt to reduce tax liabilities and increase value.
It can put a downward pressure on equity values. Both managerial styles exercise according to their own judgments and analytical approaches about the proper capital structure.14 Important Factors Affecting the Choice of Capital Structure. Article shared by: ADVERTISEMENTS: Under the capital structure, decision the proportion of long-term sources of capital is determined.
Most favourable proportion determines the optimum capital structure. Capital structure is influenced by the industry to which a company. One of the major considerations that overseers of firms must take into account when planning out capital structure is the cost of capital.
The expected return on an asset is compared to the cost of capital to invest in the asset. Important Considerations in Determining Capital Structure of a Company. Important Considerations in Determining Capital Structure of a Company.
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Factors Affecting Capital Structure Decisions. mbalectures when the firm’s financial position is so week that the use of debt may cause serious risk of default then the control considerations could lead to use either debt or equity. Low rated companies which are in need of capital either go for the stock market or the short-term debt.
Capital Structure is referred to as the ratio of different kinds of securities raised by a firm as long-term finance. The capital structure involves two decisions- Type of securities to be issued are equity shares, preference shares and long term borrowings (Debentures). Relative ratio of securities.Download