Question

. Describe the trade-off that defines the static theory of capital structure. 2. What are the important factors in making capital structure decisions

Answer 1

Q:1: Trade off theory of Capital Structure.

Ans:- Trade off theory that defines the theory of capital structure clearly states that company uses both equity and debt to raise its fund for business.So equity and debt capital mix will create optimum capital structure for firm.

That optimum capital structure decision is a function of trade of between tax benefit arise due to debt use and bankruptcy related costs.

This theory provides information about how much debt capital and how much equity capital required for company to attain optimum capital structure along with it balance the cost of bankruptcy due to overdebt taken by company and tax benefit for debt fund use.

Q;2: Factors affecting capital structure decision?

Ans;- Capital structure decision is the major decision taken by companies as it affects its revenue and stock price . some factor which is deemed to be very important as discuused below;

a:- Financial leverage;- Fiancial leverage is the main factor as company takes debt or borrowing which must satisfy its requirement to expand its busines. leverage ratio and debt ratio decides this before taking steps.

b; Management control:- Board of control is the main decision maker while taking important actions related to capital structure decision.

c: Cash flow:- Firm must follow correct cash flow to take capital structure decision.

d:Market condition:- Market condition needs to be analysed by company management as it affects its profitability and stock price.

e: Inflation, interest rate, cost of capital etc:- Inflation plays great role because it affects the productivity of firm, Interset rate on debt and bond affects the company's profitabilty. Cost of capital which includes cost of debt and equity measures cost of issuing shares.

f: Size and Nature of business and firm:- It matters more if we miss size of business as it require for capital or fund requirement for operation . Like wise nature of business is also important in capital decision making.