Question

Identify four most important firm-specific factors that affect capital structure decisions.

Answer 1

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Answer:

1) Risk factors

The higher proportion of debt increases the financial risk of the company with regard to fixed charges and repayment of principal amount in time. It is preferrable to have lower debt hence lower risk and the volatility of earnings will be more

2) Cost of capital

WACC  influences the capital structuring decisions of an organization. A company should posses earning power to generate EBIT to meet its cost of capital and finance its sustainable growth. Organizations that adjust their capital structure in order to mitigate the obliagations of their debt and equity reasonable, should have a lower cost of capital and hence lower risk.

3) Size of the company

Size of the company will decide whether the company has the requirements to meet its finance requirements. If a firm needs more capital, number of different instruments will be chosen with ease based on the size of the company for its capital structure.

4) Characteristics of the Economy:

The enivornment of business activities, state of the market in debt and equity finance, state regulation and guidelines, taxation and financial policies are some of the significant aspects of the economy which have a strong impact on capital structure decision.