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) Determinants of Capital Structure:

• Profitability: Entities with high Return on Investment (ROI) can leverage debt, as their returns are anticipated to exceed borrowing costs.
• Issuance Expenses: The costs associated with issuing securities. Debt issuance typically incurs lower floatation costs compared to equity.
• Adaptability: An effective capital structure allows for agile fundraising without restrictive limitations.

(b) Determinants of Working Capital Needs:

• Industry Type: Businesses involved in trading typically demand greater working capital than manufacturing entities due to elevated immediate inventory and liquidity demands.
• Economic Cycle: During periods of economic expansion, working capital requirements escalate as a consequence of augmented sales and production volumes.
• Price Increases: With rising price levels, increased funding is necessitated to maintain equivalent inventory and operational expenditures.

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