Page 4 - Lesson Note 2

(a) Cost: The cost of raising funds through different sources is different. A prudent

financial manager would normally opt for a source which is the cheapest.

(b) Risk: The risk associated with each of the sources is different.

(c) Floatation Costs: Higher the floatation cost, less attractive the source.

(d) Cash Flow Position of the Company: A stronger cash flow position may make
debt financing more viable than funding through equity.

(e) Fixed Operating Costs: If a business has high fixed operating costs (e.g.,

building rent, Insurance premium, Salaries, etc.), It must reduce fixed financing
costs. Hence, lower debt financing is better. Similarly, if fixed operating cost is
less, more of debt financing may be preferred.

(f) Control Considerations: Issues of more equity may lead to dilution of

management’s control over the business. Debt financing has no such implication.
Companies afraid of a takeover bid would prefer debt to equity.

(g) State of Capital Market: Health of the capital market may also affect the
choice of source of fund. During the period when stock market is rising, more

people invest in equity. However, depressed capital market may make issue of
equity shares difficult for any company.