Explain briefly any four factors that affect the choice of capital structure of a company.

Factors affecting capital Structure:

(i) Cash Flow Position: Decision regarding capital structure depends upon the ability of a business to generate enough cash flow. If a company is sure of generating enough cash flow, it may have more debt securities whereas if there is a shortage of cash, it may go for equity.

(ii) Interest Coverage Ratio (ICR): It shows how many times the earnings before interest and tax is available to the payment of interest. Higher ICR means the company has less borrowed funds whereas, it is possible that in spite of better ICR the cash flow position of the company may be weak.

(iii) Debt Service Coverage Ratio (DSCR): It is one step ahead of ICR. It takes care of the return of interest as well as principal repayment. Higher DSCR means, the company can have more debt and lower DSCR means, the company should go for equity capital.

(iv) Return on Investment: If return on investment is more than the rate of interest then the company can prefer debt in its capital structure but if the return on investment is less than the rate of interest then, the company should prefer equity as it will not be able to pay interest.

Leave a Comment

Your email address will not be published.