11.8 Factors affecting capital structure Flashcards
What factors must a company consider when determining the optimal capital structure?
- financial gearing - would debt push this too high?
- growth - would debt restrict growth?
- cost - the cost of capital should be minimised
- risks - are they acceptable?
- control - will ownership be diluted?
- market conditions - interest rates etc.
- tax exposure
- rules and regulations
What factors relating to financial gearing must be considered when determining the optimal capital structure?
Increasing gearing (with debt) also increases shareholder risks by reducing their earnings (due to repaying interest)
What factors relating to growth must be considered when determining the optimal capital structure?
The high cost of servicing debts may restrict growth.
What factors relating to the cost principle must be considered when determining the optimal capital structure?
Debt capital is cheaper than equity capital because it is less risky, and debt capital interest is also tax deductible, but dividends are not.
What factors relating to risk must be considered when determining the optimal capital structure?
1 Business risk - the possibility a company will have inadequate profit or even losses
2 Operating risk - risk of disruption of core operation
3 Financial risk - risk of financing, including defaulting on payments, bad investments etc.
What factors relating to the control principle must be considered when determining the optimal capital structure?
Raising share equity may reduce shareholders’ control, whereas debt will not.
What factors relating to market conditions must be considered when determining the optimal capital structure?
The state of the market may affect interest rates etc,
What factors relating to tax exposure must be considered when determining the optimal capital structure?
Tax deductibility of debt must be taken into account as this may make debt financing more attractive.
