Explain any six factors that determine the capital structure of a company.

Answer – Capital structure is the proportion of debt and equity in the long-term finance of a business. Debt is generally cheaper but creates obligatory payments and financial risk; equity absorbs business risk but may dilute control and require a higher expected return. Financial structure is broader because it also includes short-term liabilities; capitalisation refers to the amount of long-term capital.

Determinants

• Cash-flow position: consider ability to pay interest and principal on time.
• Interest coverage ratio: EBIT ÷ interest; a higher ratio gives a larger cushion for interest payments.
• Debt-service coverage ratio: cash available for debt service relative to interest and principal commitments gives a fuller payment-capacity measure.
• Return on investment: debt may benefit equity holders when ROI exceeds debt cost.
• Cost of debt: cheaper borrowing can encourage debt, subject to risk.
• Tax rate: tax deductibility of interest can lower the effective debt cost.
• Cost of equity: excessive debt raises shareholders' risk and required return.
• Flotation costs: compare the cost of raising different sources.
• Risk: high business risk calls for caution about additional financial risk.
• Flexibility: preserve borrowing capacity for unexpected needs.
• Control: equity issues may dilute control; debt normally does not.
• Regulatory framework: observe applicable legal requirements.
• Stock-market conditions: favourable equity markets may support share issues.
• Other companies' structures: industry practice provides a reference, not an automatic rule.

Formula reference

EPS = (Profit after tax − Preference dividend) ÷ Number of equity shares.

ROI = EBIT ÷ Capital employed × 100.

ICR = EBIT ÷ Interest.

DSCR = (Profit after tax + Depreciation + Interest + Other non-cash expenses) ÷ (Preference dividend + Interest + Principal repayment obligation).

Use consistent periods and avoid counting depreciation twice within other non-cash expenses. A higher coverage ratio generally indicates a larger payment cushion, but cash-flow timing still matters.