This document provides a comparison of debt and equity financing. It discusses the key differences, including that debt represents funds owed that must be repaid with interest, while equity represents ownership in the company. It outlines advantages and disadvantages of both debt, such as tax benefits but also repayment requirements, and equity, such as no repayment but giving up some control. The document also summarizes several key areas of financial management like determining financial needs, sources of funds, financial analysis, capital budgeting, working capital management, and profit planning and control.

1. Comparison Chart
BASIS FOR
COMPARISON
DEBT EQUITY
Meaning
Funds owed by the company
towards another party is
known as Debt.
Funds raised by the
company by issuing shares
is known as Equity.
What is it? Loan Funds Own Funds
Reflects Obligation Ownership
Term Comparatively short term Long term
Status of holders Lenders Proprietors
Risk Less High
Types
Term loan, Debentures,
Bonds etc.
Shares and Stocks.
Return Interest Dividend
Nature of return Fixed and regular Variable and irregular
Collateral
Essential to secure loans, but
funds can be raised otherwise Not required
Definition of Debt
Money raised by the company in the form of borrowed capital is known as
Debt. It represents that the company owes money towards another person or
entity. They are the cheapest source of finance as their cost of capital is lower
than the cost of equity and preference shares. Funds raised through debt
financing are to be repaid after the expiry of the specific term.

2. Definition of Equity
In finance, Equity refers to the Net Worth of the company. It is the source of
permanent capital. It is the owner’s funds which are divided into some shares.
By investing in equity, an investor gets an equal portion of ownership in the
company, in which he has invested his money. The investment in equity costs
higher than investing in debt.
ADVANTAGES OF DEBT
 Retain control. When you agree to debt financing from a lending institution, the
lender has no say in how you manage your company. You make all the
decisions. The business relationship ends once you have repaid the loan in
full.
 Tax advantage. The amount you pay in interest is tax deductible, effectively
reducing your net obligation.
 Easier planning. You know well in advance exactly how much principal and
interest you will pay back each month. This makes it easier to budget and
make financial plans.
DISADVANTAGES OF DEBT
Debt financing has its limitations and drawbacks.
 Qualification requirements. You need to have a good enough credit rating to receive
financing.
 Discipline. You’ll need to have the financial discipline to make repayments on time.
Exercise restraint and use good financial judgment when you use debt. A business
that is overly dependent on debt could be seen as ‘high risk’ by potential investors,
and that could limit access to equity financing at some point.
 Collateral. By agreeing to provide collateral to the lender, you could put some
business assets at potential risk. You might also be asked to personally guarantee the
loan, potentially putting your own assets at risk.
ADVANTAGES EQUITY
 Less burden. With equity financing, there is no loan to repay. This offers relief in
several ways. First, the business doesn’t have to make a monthly loan payment. This
can be particularly important if the business doesn’t initially generate a profit. This
also frees you to channel more money into growing the business.

3.  Credit issues gone. If you lack creditworthiness—through a poor credit history or lack
of a financial track record—equity can be preferable or more suitable than debt
financing.
 Learn, gain from partners. With equity financing, you might form partnerships—
informal, perhaps—with more knowledgeable or experienced individuals. Some
might be well connected. If so, your business could benefit from their knowledge
and their business network.
DISADVANTAGES OF EQUITY
 Share profit. Your investors will expect—and deserve—a piece of your profits.
However, it could be a worthwhile trade-off if you are benefiting from the value
they bring as financial backers and/or their business acumen and experience.
 Loss of control. The price to pay for equity financing and all of its potential
advantages is that you need to share control of the company.
 Potential conflict. Sharing ownership and having to work with others could lead to
some tension and even conflict if there are differences in vision, management style
and ways of running the business. It can be an issue to consider carefully.
Functional Areas of Financial Management
1. Determining Financial Needs:
A finance manager is supposed to meet financial needs of the enterprise. For this
purpose, he should determine financial needs of the concern. Funds are needed to
meet promotional expenses, fixed and working capital needs. The requirement of
fixed assets is related to the type of industry. A manufacturing concern will require
more investments in fixed assets than a trading concern. The working capital needs
depend upon the scale of operations, larger the scale of operations, the higher will
be the needs for working capital. A wrong assessment of financial needs may
jeopardies the survival of a concern.
2. Selecting the Sources of Funds:
A number of sources may be available for raising funds. A concern may resort to
issue of share capital and debentures. Financial institutions may be requested to
provide long-term funds. The working capital needs may be met by getting cash
credit or overdraft facilities from commercial banks. A finance manager has to be
very careful and cautious in approaching different sources. The terms and

4. conditions of banks may not be favourable to the concern. A small concern may
find difficulties in raising funds for want of adequate securities or due to its
reputation. The selection of a suitable source of funds will influence the
profitability of the concern. This selection should be made with great caution.
3. Financial Analysis and Interpretation:
The analysis and interpretation of financial statements is an important task of a
finance manager. He is expected to know about the profitability, liquidity position,
short-term and long-term financial position of the concern. For this purpose, a
number of ratios have to be calculated. The interpretation of various ratios is also
essential to reach certain conclusions. Financial analysis and interpretation has
become an important area of financial management.
4. Cost-Volume-Profit Analysis:
Cost-volume-profit analysis is an important tool of profit planning. It answers
questions like, what is the behaviour of cost and volume? At what point of
production a firm will be able to recover its costs? How much a firm should
produce to earn a desired profit? To understand cost-volume-profit relationship,
one should know the behaviour of costs. The costs may be subdivided as: fixed
costs, variable costs and semi-variable costs. Fixed costs remain constant
irrespective of changes in production.
5. Capital Budgeting:
Capital budgeting is the process of making investment decisions in capital
expenditures. It is an expenditure the benefits of which are expected to be received
over a period of time exceeding one year. It is an expenditure incurred for
acquiring or improving the fixed assets, the benefits of which are expected to be
received over a number of years in future. Capital budgeting decisions are vital to
any organization. An unsound investment decision may prove to be fatal for the
very existence of the concern

5. 6. Working Capital Management:
Working capital is the life blood and nerve centre of a business. Just as circulation
of blood is essential in the human body for maintaining life, working capital is
essential to maintain the smooth running of business. No business can run
successfully without an adequate amount of working capital. Working capital
refers to that part of the firm’s capital which is required for financing short-term or
current assets such as cash, receivables and inventories. It is essential to maintain a
proper level of these assets. Finance manager is required to determine the quantum
of such assets. Cash is required to meet day-to-day needs and purchase inventories
etc.
The scarcity of cash may adversely affect the reputation of a concern. The
receivables management is related to the volume of production and sales. For
increasing sales, there may be a need to give more credit facilities. Though sales
may go up but the risk of bad debts and cost involved in it may have to be weighed
against the benefits. Inventory control is also an important factor in working capital
management. The inadequacy of inventory may cause delays or stoppages of work.
Excess inventory, on the other hand, may result in blocking of money in stocks,
more costs in stock maintaining etc. Proper management of working capital is an
important area of financial management.
7. Profit Planning and Control:
Profit planning and control is an important responsibility of the financial manager.
Profit maximization is, generally, considered to be an important objective of a
business. Profit is also used as a tool for evaluating the performance of
management. Profit is determined by the volume of revenue and expenditure.
Revenue may accrue from sales, investments in outside securities or income from
other sources. The expenditures may include manufacturing costs, trading

6. expenses, office and administrative expenses, selling and distribution expenses and
financial costs.
Concept of cost of capital:
A firm raises funds from various sources, which are called the components of
capital. Different sources of fund or the components of capital have different costs.
For example, the cost of raising funds through issuing equity shares is different
from that of raising funds through issuing preference shares. The cost of each
source is the specific cost of that source, the average of which gives the overall
cost for acquiring capital.
L. J. Gitman defines the cost of capital as ‘the rate of return a firm must earn on its
investment so the market value of the firm remains unchanged’.
According to Ezra Solomon, ‘the cost of capital is the minimum required rate of
earnings or the cut-off rate of capital expenditure’.
Significance of cost of capital
1) Helps in evaluating financial performance: if the actual profit of the project
is more than the expectation and the actual cost of capital than the performance is
said to be satisfactory.
2) Helps in determining capital mix in capital structure decisions: it is a
rule that there should be a proper debt equity mix and the management has to keep
in mind that the optimum capital structure results in maximum value of the firm and
minimize the cost of capital.
3) Act as acceptance criteria in capital budgeting: If the present value of
expected return from the investment is > or = cost of investment the project may be
accepted otherwise rejected.
4) Helps in taking financial decisions: it helps in taking financial decisions like
dividend policy, capitalization of profits, of working capital.

7. factors which affect the cost of capital
1. Current Economic Conditions
If banks are growing, they can easily give loan at low rate of interest because they need to
increase the sale for stability of their products. At that time, company's cost of debt will decrease
which is the part of company's cost of capital. Not just bank but whole economic conditions
should be ok for this. If there is big recession in the market, no financial institute will decrease the
rate of interest because they also have to pay the return to their customers. It means, every loan
providing company has also cost of capital. If there will be stability in the market, cost of debt will
decrease and cost of equity capital will increase.
2. Current Capital Structure
When we have studied optimal capital structure, we have to study the cost of capital because for
optimal capital structure, we need to calculate weighted average cost of capital. But if company
did not consider cost of capital as factor, we can include the study of current capital structure as
the factor for cost of capital. Current debt equity ratio will effect the cost of capital. If debt is more
than share capital, we have to pay more cost of debt. If share capital is more than debt, we have
to pay cost of equity or pref. share capital.
3. Current Dividend Policy
Every company has to make dividend policy. What amount of total earning, company is
interested to pay as dividend. For this, we have to study Price-Earning Ratio (Dividend/EPS). If
Price earning ratio will increase, cost of retained earning will decrease because we will less
money which have retained and use for promoting of business as source of fund.
4. Getting of New Fund
Company's new fund's requirement will also affect the cost of capital. If company needs $ 20
million dollars immediately for business promotion, company will have to pay high rate of interest
because with this, risk of financial institution will increase. Every loan provider works with
patience, he needs to analyze the company before providing big loan. If he will give big loan
immediately, it is sure, he will get more return from company and company has to pay more cost
of this. Except this, every time, when company will go to market for getting fund, company
company will get the money at new market rate. So, company has also to follow new rate of cost
of capital. It may increase or decrease company's current cost of capital rate.

8. 4. Financial and Investment Decisions
When we get new share capital or debt, we have to tell to fund providers about the usage of their
fund. If there is more risk in the investment, both shareholders and creditors will get high reward
for this. So, our financial and investment decisions will effect the cost of capital.
5. Current Income Tax Rates
We know, we charge the interest before tax charges. When we earn money, we deduct our
interest charges, then we deduct tax charges. So, if tax rate will high, it will effect the cost of
share capital because with high tax charges, our net earn will decrease and it will decrease
earning per share. So, we will give less dividend to our shareholders.
6. Breakpoint of Marginal Cost of Capital
Marginal cost of capital is the cost raising one more unit of capital. Its breakpoint will affect the
cost of capital. Before studying, how marginal cost of capital affects current cost of capital, we
have to understand the breakpoint of marginal cost of capital
Break Point = Amount of Capital at which Sources Cost of Capital Changes/Proportion of
New Capital Raised from the Source
Following are main breakpoint
a) Break-point of Debt
b)Break-point of Pref. Share
c) Break-point of equity share capital
Cost Of Retained Earnings
The cost of retained earnings can be measured as follows:
1. Where there are no taxes and brokerage fees:
Kr = Ke = D1 + g
P0
Where:
Kr = Cost of retained earnings

9. Ke = Cost of equity capital
D1 = Expected Dividend at the end of Year 1
P0 = Current price of the stock
g = Growth rate
2. Where there are taxes and brokerage fees:
Kr = Ke (1 - T) (1 - B)
Where:
T = Marginal tax rate of shareholder and
B = Brokerage or commission to acquire new shares.
determinants of dividend
(i) Type of Industry:
Industries that are characterised by stability of earnings may formulate a more
consistent policy as to dividends than those having an uneven flow of income. For
example, public utilities concerns are in a much better position to adopt a relatively
fixed dividend rate than the industrial concerns.
(ii) Age of Corporation:
Newly established enterprises require most of their earning for plant improvement
and expansion, while old companies which have attained a longer earning
experience, can formulate clear cut dividend policies and may even be liberal in
the distribution of dividends.
(iii) Extent of share distribution:
A closely held company is likely to get consent of the shareholders for the
suspension of dividends or for following a conservative dividend policy. But a
company with a large number of shareholders widely scattered would face a great
difficulty in securing such assent. Reduction in dividends can be affected but not
without the co-operation of shareholders.
(iv) Need for additional Capital:
The extent to which the profits are ploughed back into the business has got a
considerable influence on the dividend policy. The income may be conserved for
meeting the increased requirements of working capital or future expansion.

10. (v) Business Cycles:
During the boom, prudent corporate management creates good reserves for facing
the crisis which follows the inflationary period. Higher rates of dividend are used
as a tool for marketing the securities in an otherwise depressed market.
(vi) Changes in Government Policies:
Sometimes government limits the rate of dividend declared by companies in a
particular industry or in all spheres of business activity. The Government put
temporary restrictions on payment of dividends by companies in July 1974 by
making amendment in the Indian Companies Act, 1956. The restrictions were
removed in 1975.
(vii) Trends of profits:
The past trend of the company’s profit should be thoroughly examined to find out
the average earning position of the company. The average earnings should be
subjected to the trends of general economic conditions. If depression is
approaching, only a conservative dividend policy can be regarded as prudent.
(viii) Taxation policy:
Corporate taxes affect dividends directly and indirectly— directly, in as much as
they reduce the residual profits after tax available for shareholders and indirectly,
as the distribution of dividends beyond a certain limit is itself subject to tax. At
present, the amount of dividend declared is tax free in the hands of shareholders.
(ix) Future Requirements:
Accumulation of profits becomes necessary to provide against contingencies (or
hazards) of the business, to finance future- expansion of the business and to
modernise or replace equipments of the enterprise. The conflicting claims of
dividends and accumulations should be equitably settled by the management.
(x) Cash Balance:

11. If the working capital of the company is small liberal policy of cash dividend
cannot be adopted. Dividend has to take the form of bonus shares issued to the
members in lieu of cash payment.
The regularity of dividend payment and the stability of its rate are the two main
objectives aimed at by the corporate management. They are accepted as desirable
for the corporation’s credit standing and for the welfare of shareholders.
Objectives of cash management
1. To Make Payment According to Payment Schedule
1. To prevent firm from being insolvent.
2. The relation of firm with bank does not deteriorate.
3. Contingencies can be met easily.
4. It helps firm to maintain good relation with suppliers.
2. To Minimise Cash Balance
Excessive amount of cash balance helps in quicker payments, but excessive cash may
remain unused & reduces profitability of business. Contrarily, when cash available with
firm is less, firm is unable to pay its liabilities in time. Therefore optimum level of cash
should be maintain.
The objectives of cash management can be :
1. To ensure sufficient liquidity
2. To meet working capital requirements
3. To be able to meet short term requirements forming part of administrative activities for
running a business.

12. 4. To not use capital funds for short term requirements, thereby leading to capital erosion.
5. An indirect objective would be to ensure stakeholders wealth maximization which serves
as the basic premise for all the objectives.
The most common types of Marketable Securities are:
1. Equity Securities
2. Bonds – Fixed Income Securities
3. Option Securities
4. Mutual Funds
5. Unit Investment Trusts
6. Commodities
7. Derivatives
COST OF RECEIVABLES
1.Cost of financing :
The credit sales delays the time of sales realization & therefore the time gap between incurring the cost &
the sales realization is extended . This results in blocking of funds for a longer period. The firm on the
other hand , has to arrange funds to meet its own obligations towards payment to the supplier, employees
etc., These funds are to be procured at some explicit or implicit cost . This is known as cost of financing
the receivables.
2.Administrative cost:
A firm will also required to incur various costs in order to maintain the record of credit customers both
before the credit sales as well as after the credit sales
3. Dliquency Cost :
The firm have to incur additional costs known as delinquency costs, if there is delay in the payment by a
customer. The firm may have to incur cost on reminders , phone calls , postages, legal notices etc. There is
always an opportunity cost of the funds tied up in the receivables due to delay in payment.
4.Cost of default by the Customer:

13. If there is a default by the customer & the receivables becomes partly or wholly, unrealizable , then this
amount is known as bad debt, also becomes cost to the firm. This cost does not appear in case of sales.
BENEFITS OF RECEIVABLES
1. Increase in sales:
Most of the firms sell goods on credit, either because of trade customs or other conditions. The sales can be
further increased by liberalizing the credit terms. This will attract more customers to the firm resulting in
higher sales & growth of the firm.
2. Increase in profits:
Increase in sales help the firm in
a)to easily recover the fixed expenses & attaining the break-even level.
b)Increase the operating profit of the firm
3. Extra profit:
Sometimes, the firm makes the credit sales higher than the usual cash selling price. This brings an
opportunity to the firm to make extra profit over & above the normal profit.
Meaning of Capital Budgeting
Capital Budgeting is the process of making investment decision in fixed assets or capital expenditure.
Capital Budgeting is also known as investment, decision making, planning of capital acquisition, planning
and analysis of capital expenditure etc.
Objectives of Capital Budgeting
The following are the objectives of capital budgeting.
1. To find out the profitable capital expenditure.
2. To know whether the replacement of any existing fixed assets gives more return than earlier.
3. To decide whether a specified project is to be selected or not.
4. To find out the quantum of finance required for the capital expenditure.
5. To assess the various sources of finance for capital expenditure.
6. To evaluate the merits of each proposal to decide which project is best.

14. Features of Capital Budgeting
The features of capital budgeting are briefly explained below:
1. Capital budgeting involves the investment of funds currently for getting benefits in the future.
2. Generally, the future benefits are spread over several years.
3. The long term investment is fixed.
4. The investments made in the project is determining the financial condition of business organization in
future.
5. Each project involves huge amount of funds.
6. Capital expenditure decisions are irreversible.
7. The profitability of the business concern is based on the quantum of investments made in the project.
Limitations of Capital Budgeting
The following are the limitations of capital budgeting.
1. The economic life of the project and annual cash inflows are only an estimation. The actual economic
life of the project is either increased or decreased. Likewise, the actual annual cash inflows may be either
more or less than the estimation. Hence, control over capital expenditure can not be exercised.
2. Capital budgeting process does not take into consideration of various non-financial aspects of the
projects while they play an important role in successfuland profitable implementation of them. Hence, true
profitability of the project cannot be highlighted.
3. It is also not correct to assume that mathematically exact techniques always produce highly accurate
results.
4. All the techniques of capital budgeting presume that various investment proposals under consideration
are mutually exclusive which may not be practically true in some particular circumstances
CAPITAL BUDGETING PROCESS:
A) Project identification and generation:
The first step towards capital budgeting is to generate a proposal for investments. There could
be various reasons for taking up investments in a business. It could be addition of a new
product line or expanding the existing one. It could be a proposal to either increase the
production or reduce the costs of outputs.
B) Project Screening and Evaluation:
This step mainly involves selecting all correct criteria’s to judge the desirability of a
proposal. This has to match the objective of the firm to maximize its market value. The tool
of time value of money comes handy in this step.

15. Also the estimation of the benefits and the costs needs to be done. The total cash inflow and
outflow along with the uncertainties and risks associated with the proposal has to be analyzed
thoroughly and appropriate provisioning has to be done for the same.
C) Project Selection:
There is no such defined method for the selection of a proposal for investments as different
businesses have different requirements. That is why, the approval of an investment proposal
is done based on the selection criteria and screening process which is defined for every firm
keeping in mind the objectives of the investment being undertaken.
Once the proposal has been finalized, the different alternatives for raising or acquiring funds
have to be explored by the finance team. This is called preparing the capital budget. The
average cost of funds has to be reduced. A detailed procedure for periodical reports and
tracking the project for the lifetime needs to be streamlined in the initial phase itself. The
final approvals are based on profitability, Economic constituents, viability and market
conditions.
D) Implementation:
Money is spent and thus proposal is implemented. The different responsibilities like
implementing the proposals, completion of the project within the requisite time period and
reduction of cost are allotted. The management then takes up the task of monitoring and
containing the implementation of the proposals.
E) Performance review:
The final stage of capital budgeting involves comparison of actual results with the standard
ones. The unfavorable results are identified and removing the various difficulties of the
projects helps for future selection and execution of the proposals.
What is 'Weighted Average Cost Of Capital - WACC'
Weighted average cost of capital (WACC) is a calculation of a firm's cost of capital in which
each category of capital is proportionately weighted.
All sources of capital, including common stock, preferred stock, bonds and any other long-term
debt, are included in a WACC calculation. A firm’s WACC increases as the beta and rate of
return on equity increase, as an increase in WACC denotes a decrease in valuation and an
increase in risk.
To calculate WACC, multiply the cost of each capital component by its proportional weight and
take the sum of the results. The method for calculating WACC can be expressed in the following
formula:
Where:
Re = cost of equity
Rd = cost of debt

16. E = market value of the firm's equity
D = market value of the firm's debt
V = E + D = total market value of the firm’s financing (equity and debt)
E/V = percentage of financing that is equity
D/V = percentage of financing that is debt
Tc = corporate tax rate
1. Book-Value Weights:
Under this method, weights are the relative proportions of various sources of
capital to the total capital structure of a firm.
The advantages of these weights are operational in nature since book-values are
easily available from the published annual report of a firm
2. Market-value Weights:
Theoretically, the use of market value weights for calculating the cost of
capital is more appealing due to the following reasons:
(a) The market value of the securities are closely approximate to the actual amount
to be received from the proceeds of such securities.
(b) The cost of each specific source of finance which constitutes the capital
structure is calculated according to the prevailing market price.
Concept of Capital Structure:
The relative proportion of various sources of funds used in a business is termed as
financial structure. Capital structure is a part of the financial structure and refers to
the proportion of the various long-term sources of financing. It is concerned with
making the array of the sources of the funds in a proper manner, which is in
relative magnitude and proportion.
According to Gerestenberg, ‘capital structure of a company refers to the
composition or make up of its capitalization and it includes all long term capital
resources viz., loans, reserves, shares and bonds’. Keown et al. defined capital

17. structure as, ‘balancing the array of funds sources in a proper manner, i.e. in
relative magnitude or in proportions’.
Importance (significance) of Capital Structure:
Value Maximization:
Capital structure maximizes the market value of a firm, i.e. in a firm having a
properly designed capital structure the aggregate value of the claims and ownership
interests of the shareholders are maximized.
Cost Minimization:
Capital structure minimizes the firm’s cost of capital or cost of financing. By
determining a proper mix of fund sources, a firm can keep the overall cost of
capital to the lowest.
Increase in Share Price:
Capital structure maximizes the company’s market price of share by increasing
earnings per share of the ordinary shareholders. It also increases dividend receipt
of the shareholders.
Investment Opportunity:
Capital structure increases the ability of the company to find new wealth- creating
investment opportunities. With proper capital gearing it also increases the
confidence of suppliers of debt.
Growth of the Country:
Capital structure increases the country’s rate of investment and growth by
increasing the firm’s opportunity to engage in future wealth-creating investments.

18. Determinants of Capital Structure of a Firm:
There are numerous factors, both qualitative and quantitative, including the subjec-
tive judgment, of financial managers which conjointly determine a firm’s capital
structure. We may now briefly discuss the key factors governing a firm’s capital
structure decisions.
The main factors are the following:
1. Profitability:
The key word in capital structure is leverage. It can be defined as the employment
of an asset or sources of funds for which the firm has to incur a fixed cost or pay a
fixed sum (as the return per period).
Operating v. Financial:
Leverage is of two types ‘operating’ and ‘financial’. The leverage associated with
investment (or acquisition of assets) activities is referred to as operating leverage,
while leverage associated with financing activities is called financial leverage. In
general, the higher the level of (EBIT) and the lower the chance of downward
fluctuation the larger the amount of debt that can be employed.
2. Liquidity:
The analysis of the cash flow ability of the firm to service fixed charges is of
considerable importance to carry out capital structure planning.
The Coverage Ratio:
In assessing the liquidity position of a firm in terms of its cash flow analysis, we
use a ratio called the coverage ratio. It is the ratio of fixed charges to net cash
inflows. It measures the coverage of fixed financial charges (interest plus
repayment of principal, if any) to net cash inflows.

19. In other words, it indicates the number of times the fixed financial requirements
are covered by the net cash inflows. The higher the coverage ratio the larger the
amount of debt (and other sources of funds carrying a fixed rate of interest) that a
firm can use.
3. Control:
Another consideration in planning the types of funds to use is the attitude of
existing management towards control. Lenders have no direct voice in the
management of a company. In most cases, the power to choose the management
team rests with the equity holders.
Accordingly, if the main objective of management is to maintain control, they may
like to have a greater weight-age for debt and preference share in additional capital
requirements. This is so because by obtaining funds through them the management
sacrifices little or no control.
4. Competitive Parity:
Another factor determining a company’s optimal capital structure is the debt-
equity ratios of other companies belonging to the same industry and facing a
similar business risk. The rationale here is that the debt-equity ratios appropriate
for other firms in a similar line of business should be appropriate for the company
(under consideration) as well. The use of industry standards provides a benchmark.
If a firm is deviating from its optimal capital structure, the market will give a red
signal to the management that there is something wrong in the company’s debt-
equity mix. If the firm is out of line, it should identify the causes of such deviation
and be satisfied that the reasons are genuine.
5. The Nature of Industry:
The fifth determinant of a firm’s optimal capital structure is the nature of the
industry to which it belongs. The nature of industry largely determines the degree

20. of financial leverage the firm can carry safely without any risk of bankruptcy. If an
industry’s sales are subject to periodic fluctuations, the firm should have a low
degree of financial leverage. Such firms will always have high operating leverage.
6. Timing of Issue:
The question of timing of issue is also of considerable importance in determining a
company’s capital structure. It is often possible to make substantial savings
through proper timing of security issues. It is in the Tightness of things to make
public offering at a time when the state of the economy as well as the capital
market is ideal for providing the required funds.
However, timing should not be the only consideration. “Timing analysis, for
example, may suggest use of debt. But the company cannot go in for debt if its
existing capital structure is already overloaded with debt.
7. Characteristics of the Company:
The nature and characteristics of the company in terms of its size, capital structure
and goodwill (credit-standing) also play a very important role in determining the
share of old securities and equity in its capital structure.