Question

Factors affecting financing decisions include:

• [A.] Risk
• [B.] Floatation cost
• [C.] Cash flow position of the company
• [D.] Taxation Policy

Choose the correct answer from the options given below:

• A. A, B and D only
• B. A, B, C only
• C. B, C and D only
• D. A, B, C and D only

Hint:

Major factors affecting financing decisions include:

• Cost of capital
• Risk involved
• Cash flow position
• Tax implications
• Floatation cost

Always remember that financing decisions aim at achieving an optimum capital structure.

Answer 1

The Correct Option is D

Concept:
Financing decisions refer to decisions related to the selection of sources of funds for a business organisation. Every company requires funds for purchasing fixed assets, meeting working capital requirements, expansion, modernization, and daily operations. While taking financing decisions, management carefully evaluates several important factors because the wrong financing decision can increase financial risk and reduce profitability. The major factors influencing financing decisions include risk, floatation cost, cash flow position, and taxation policy.

Step 1: Understanding the role of Risk.
Risk is one of the most important factors affecting financing decisions. Different sources of finance involve different levels of financial risk.

• Debt financing increases fixed financial obligations in the form of interest payments.
• If the company fails to generate sufficient income, repayment of debt becomes difficult.
• Higher debt increases financial leverage and chances of insolvency.

Therefore, management always considers the level of risk before selecting a financing source. Hence, statement A is correct.

Step 2: Understanding Floatation Cost.
Floatation cost refers to the expenses incurred while raising funds from the market. These costs include:

• Brokerage charges
• Underwriting commission
• Advertisement expenses
• Printing and legal expenses

A company generally prefers a financing source with lower floatation costs because excessive issue expenses reduce the actual amount of funds received. Hence, statement B is also correct.

Step 3: Analyzing the Cash Flow Position of the Company.
Cash flow position determines the ability of the business to meet fixed financial commitments.

• A company having stable and strong cash flows can safely use debt financing because it can regularly pay interest and principal.
• Companies with weak or uncertain cash flows generally avoid excessive debt.

Thus, the cash flow position directly influences financing decisions. Hence, statement C is correct.

Step 4: Understanding the importance of Taxation Policy.
Taxation policy also affects financing decisions because interest paid on debt is generally treated as a tax-deductible expense.

• Debt financing can reduce taxable income.
• This creates a tax advantage known as a tax shield.

Therefore, companies often compare tax benefits before choosing between debt and equity. Hence, statement D is also correct.

Step 5: Selecting the correct option.
Since all four statements correctly represent factors affecting financing decisions, the correct answer is: \[ \boxed{\text{(D) A, B, C and D only}} \]