Explain briefly any four factors which affect the choice of capital structure of a company.

The following factors decided a company's capital structure:

1. Stability of sales. For a company having a high sale turnover, a higher proportion of debt is suitable. For a company with fluctuating sales, a higher proportion of equity is suitable.

2. Cost of capital. Interest on debentures and dividend on shares is a cost of capital. Paying interest and raising capital through debentures is a better option provided the company has regular income flows. If interest rate of raising debt is lower, then debt can be used.

3. Cash flow ability of the company. A company must have enough cash in hand or liquidity if it has to raise capital through debentures to pay interest in time. If cash inflows are not enough, then it should issue shares.

Control. To retain control over the management of the company, debentures and preference shares should be issued to raise capital.

4. Flexibility. Equity allowed for more flexibility to change its capital structure according to market conditions while debt restricts this freedom.

5. Size of the company. Large companies are able to raise capital through shares more easily while smaller companies have to depend on their own sources or retained earnings as they do not get loans easily.

6. Thx rate. It will be beneficial for the company to raise funds through debt if tax rates are high. Tax rate influences coat of debt as interest is a tax deductible item.

7. Stock market conditions. If there is a boom period, then company will be in a better position to issue shares and that also at a premium. On the other hand, if there is depression in the market then investors may not be in a mood to take risks and therefore it is advisable for the company to issue debentures.

8, Risk. More risk is attached to debt as compared to shares such as interest payment, repayment, etc. If level of fixed operating costs (like rent of the building) are high, then business should go in favour of issuing more of equity instead of debt.

9. Cost of equity. More debt means more risk for the equity holders which increases their desired rate of return. To control cost of equity, limit should be imposed on the use of debt.

10. Return on investment. Trading on equity/financial coverage can be used to increase earnings per share if ROI is higher.

11. Flotation costs. It refers to costs involved in the issue of share or debentures. Flotation costs are high in case of equity as compared to debt.

12. Interest Coverage Ratio ICR - Earnings before interest and taxes/ Interest

Risk of company is lower if ICR is higher. But it is not a full proof measure.