Question

when a company is trying to decide on which capitalization option is best for the company why are the following three important?

Company’s capital structure,

Company’s working capital and

Asset performance of the company.

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Answer 1

Company's capital structure: By default all the projects that take place within the company adhere to the target capital structure as defined by the company as a whole. For example if the target capital structure of the business as a whole is 60% equity and 40% debt, then all the divisions and projects that happen within the company will have to align themselves with the defined target capital structure.

Company's working capital: The business needs to evaluate its impact on the current assets and current liabilities which will impact the working capital. If the current liabilities are high, the working capital requirements may be more which will reduce the operating cash flow and affect the net present value.

Asset performance of the company: The asset utilization is of at most important when choosing the capitalization method. The business needs to decide if the assets are fully utilized for generating the sales. If the assets are fully utilized, the business may have to purchase additional plant, property and equipment to meet the output needs. This may result in higher initial costs and lower the net present value.