What is the aim of capital structure planning?

Choosing the mix of long-term funds so cost of capital is lowest and firm value is highest

Maximising only the short-term borrowing of the firm

Deciding the day-to-day working capital level

Distributing all profit as dividend

A firm with strong, stable cash flow should generally:

Use more equity because debt is unsafe

When does debt increase EPS (positive leverage)?

When return on investment is greater than the interest rate

When return on investment is less than the interest rate

Which statement about marketability is correct?

Equity is issued in a strong share market and debt is preferred when share prices are low

Debt is preferred when share prices are high

Marketability is the firm's unused borrowing power

It is measured by the interest coverage ratio

2067 Asar (old course) · 8 marks

Capital structure; cash flowability, leverage ratio

Short answer

Capital structure planning decides the optimal mix of debt and equity to minimize cost and maximize value. Cash flowability is the ability to generate cash for servicing debt; leverage ratio compares debt to equity and impacts EPS; flexibility allows future financing without strain; marketability is the ease of selling securities in the market.

Define capital structure planning. Explain in brief cash flowability, leverage ratio, flexibility and marketability of the company.

Capital structure planning

Capital structure is the mix of long-term sources of funds (equity shares, preference shares, retained earnings and long-term debt) used by a firm to finance its total capital. Capital structure planning is the process of deciding the best proportion of these sources so that the cost of capital is lowest and the value of the firm and return to shareholders are highest.

Cash flowability

The ability of the firm to generate sufficient cash to pay interest, tax, loan instalments and dividends. Measured by interest coverage ratio (EBIT/interest) and debt service coverage ratio. Strong, stable cash flow permits more debt; weak cash flow needs more equity.

Leverage ratio

The leverage ratio shows how much debt the firm uses compared to equity (debt-equity ratio, debt ratio = debt/total capital).

Positive leverage: if return on investment is greater than the interest rate, debt increases EPS (trading on equity).
High leverage increases the risk of default if earnings fall.

A suitable level is chosen from the earnings and the risk the firm can bear.

Flexibility

The capital structure should allow the firm to raise more funds when needed, without difficulty and at an acceptable cost. This needs unused borrowing power, low fixed commitments, and options like redeemable or convertible securities.

Marketability

It is the ease with which the firm can sell its securities in the capital market. It depends on the condition of the market (boom or recession), investor demand, the firm's reputation and the timing of issue. In a strong share market, equity is issued; when share prices are low, debt is preferred.

✓ Answer checked by Claude Opus 5.5 (high effort)

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