Question

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

Hint:

Capital structure is about long-term funding decisions; working capital is about day-to-day liquidity.

Answer 1

(a) Factors Affecting Capital Structure:

• Return on Investment: Companies earning higher ROI can use debt since they will be able to generate returns greater than the cost of debt.
• Floatation Costs: These are the costs involved in issuing securities. Debt usually involves lower floatation cost than equity.
• Flexibility: A sound capital structure provides the flexibility to raise funds as and when needed without rigidity.

(b) Factors Affecting Working Capital Requirements:

• Nature of Business: Trading firms require more working capital than manufacturing firms due to higher immediate inventory and cash needs.
• Business Cycle: In boom periods, working capital requirements are high due to increased sales and production.
• Inflation: As price levels rise, more funds are needed for same inventory and operational costs.

Final Answer: Both capital structure and working capital factors explained.