Question

Critically analyse the factors that influence capital structure decisions and corporate finance strategy within a company. (700 words)

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Answer 1

Q: Factors that affect capital structure decision of firm and corporate finance strategy.

Capital structure is the main concept in corporate restructuring and financing strategies of firm which influence the financing decision of firm for effective operation and generate profit for shareholders's wealth maximisation.

Besides shareholders' wealth maximisation , company need to take valuable capital structure decision which increases its value in the financial market. This can affect its stock price value and also brand value.

There are some important factors which affect firm's capital structure these are discussed below:-

a: Cash flows:- The expected cash flows with the firm are need to be adequate to face the shareholder dividend and interest of debenture. Company issue share and debenture to public and after maturity it pays their dividend and intrest on principal ,so to make this happen in future the firm must have sufficient free cash flows.

b:Financial leverage:- This is the one main factor which affect the capital structure decision of firm in capital mixing i.e how the firm mix equity and debt to raise its capital need for the firm. this procedure can maximise their profit in future.It can increase retained earning of firm.

c: Sale and turnover :- Sale , revenue and turnover are the same concept which makes the firm more stable if it is increased by the firm's employees and worker. it is main point for every business that its products and services are need to be well attracted by target customers, so that its sale revenue and profit from operation simultaneously increases resulting make company more liquid and stable to raise more capital through borrowing by debts. so that it can repay their intrest comfortably.

d: Management control over company:- Board of members and management of firm takes valuable steps to formulate strategies how many employees needed so that they can increase sales,. they also make decision regarding corporate restructuring aspect like merger and acquisition to increase the ability of firm to raise maximum finance for company.They decide the company financial budget what to be include to bring optimum capital structure.

e:Good and flexible financial structure;- A good financial structure is always advisable for firm as it provides more flexibiltiy in raising capital through debt and equity. It creates strong base so that company issue more preference share and debenture which are paid at later stage.

Here the main fact is to pay dividend to preference shareholders and interest to debenture or bond holders.

f: Cost of floating capital:- For company perspective it is very necessary that the cost of raisng capital to various sources of finance is estimated accordingly to decide which alternative is the cheapest. Prevailing rate of interest, expected rate of return on investment expected by available investors are the more influencing factors for cost of financing.Cost of financing is different for different companies. For reputed companies like Reliance ltd , Tata ltd , Facebook inc, Apple inc cost of financing is low as comparision to newly constructed firm.

g: Market conditions: Market condition like recession, depression, or appreciation the capital market responds accordingly to the stock price of company.Lso keeping all view company decides the time to issue its IPO in to the market or issue share , debenture to the market.Mainly in case of inflation high it affects the debt intrest rate so it influence the capital structure of firm.

h: Business Risk:-Business risk is always there. It is recognised by its managing director or board of members. Capital market pose risk on operation during sudden market crash. It affects the capital structure of firm

i: Tax implications: -Tax plays vital role in company . thus firm restructures its capital or financial budget as per tax paybility. Tax structure is amended or changed from time to time by Government of every country.

j:Financial ratio: Some financial ratios like intrest coverage ratio, time interest earned ratio , debt to equity ratio decide how much equity capital and how much debt capital are required accordingly for smooth operation of firm. Without borrowing firm cannot operate.

k:Return on Investment: Return on investment is main thing to be taken for consideration as company do invest its fund in capital market or some foreign direct investment , research and developement projects, So to calculate return from that investment avenues is very necessary as it affects the capital structuring making process in future.