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प्रश्न
Explain how 'cost of debt' affects the choice of capital structure of a company
How does ‘Cost of Debt’ affect the capital structure of a company? State.
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उत्तर १
Cost of debt affects the choice of capital structure of a company. If the firm can borrow funds at a lower rate (i.e. low cost of debt), then more debt can be raised. On the contrary, if the firm can borrow funds at a higher rate (i.e. high cost of debt), then a lesser amount of a debt will be raised
Low cost of debt ⇒ Higher Proportion of Debt in Capital Structure
High Cost of Debt ⇒ Lower Proportion of Debt in Capital Structure
उत्तर २
Debt is risky where payment of regular interest on the debt is a legal obligation of the business. If the firm can manage a borrowed fund at a lower rate of interest, then it will prefer to have more of debt as compared to equity.
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Mr. A. Bose is running a successful business. Mr. Bose is the owner of R. K. Cement Ltd. Mr. Bose decided to expand his business by acquiring a Steel Factory. This required an investment of Rs. 60 crores. To seek advice in this matter, he called his financial advisor Mr. T. Ghosh who advised him about the judicious mix of equity (40%) and Debt (60%). Employ more of cheaper debt may enhance the EPS. Mr. Ghosh also suggested him to take loan from a financial institution as the cost of raising funds from financial institutions is low. Though this will increase the financial risk but will also raise the return to equity shareholders. He also apprised him that issue of debt will not dilute the control of equity shareholders. At the same time, the interest on loan is a tax deductible expense for computation of tax liability. After due deliberations with Mr. Ghosh, Mr. Bose decided to raise funds from a financial institution.
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