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Question
Explain the following as factor affecting the choice of capital structure:
Floatation costs
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Solution
- When a business generates money by issuing securities, it faces flotation charges, which include underwriting, legal, and registration fees.
- These expenses have a big impact on the capital structure decision.
- The business may decide to use a smaller percentage of a certain funding source in its capital structure in order to save costs if the flotation costs of that funding type, such as issuing shares, are high.
- On the other hand, sources that have lower flotation costs might be more appealing.
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Viyo Ltd.' is a company manufacturing textiles. It has a share capital of Rs 60 lakhs. The earnings per share in the previous year was Rs 0.50. For diversification, the company requires additional capital of Rs 40 lakhs. The company raised funds by issuing 10% debentures for the same. During the current year the company earned profit of Rs 8 lakhs on capital employed. It paid tax @ 40%.
a. State whether the shareholders gained or lost, in respect of earning per share on diversification. Show you calculations clearly.
b. Also, state any three factors that favour the issue of debentures by the company as part of its capital structure.
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______ refers to a situation when a company is not able to meet its fixed financial charges.
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Show the working.
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