Question

(a) Explain the following factors affecting the requirement of fixed capital of a company:

• [(i)] Choice of technique
• [(ii)] Financing alternatives
• [(iii)] Growth prospects

OR (b) Explain the following factors affecting choice of capital structure of a company:

• [(i)] Cost of equity
• [(ii)] Control
• [(iii)] Stock market conditions

Hint:

Fixed capital is about "what you buy"; capital structure is about "how you fund it". Both decisions must be aligned with long-term goals and risk preferences of the business.

Answer 1

(a) Factors Affecting Requirement of Fixed Capital:

• Choice of Technique: The capital required by a business largely depends on whether it chooses capital-intensive or labour-intensive techniques. A capital-intensive enterprise (such as an automobile plant with automated assembly lines) would require more investment in fixed assets like machinery, equipment, and buildings. In contrast, labour-intensive businesses (like handloom weaving) require relatively lower fixed capital as they rely more on human labour than machines.
• Financing Alternatives: Availability of leasing or renting facilities can significantly reduce the need for huge investments in fixed assets. For example, if machinery can be taken on lease rather than purchased outright, the requirement of fixed capital reduces. Similarly, businesses may outsource functions such as transportation, which otherwise would have required purchasing trucks or vans.
• Growth Prospects: Companies with higher growth potential generally require greater fixed capital. A firm anticipating expansion or diversification in near future may invest in additional plant capacity, land, or advanced technology in advance. A start-up aiming to scale quickly across markets will likely need higher initial investment in fixed infrastructure.

OR (b) Factors Affecting Choice of Capital Structure:

• Cost of Equity: Although equity capital is a permanent source of funds, it is also considered costlier than debt. This is because dividends are not tax-deductible (unlike interest), and shareholders expect higher returns due to higher risk. Firms must balance this cost while determining their capital mix.
• Control: Issuing more equity shares may dilute the control of existing shareholders, especially promoters. Therefore, if the current owners wish to retain complete control of the firm, they may prefer debt financing even if it's costlier. Capital structure thus depends on the extent to which promoters are willing to share ownership.
• Stock Market Conditions: During a bullish market, companies may prefer to raise capital through equity because investors are willing to invest and market valuations are high. In contrast, during a bearish or volatile phase, it becomes difficult to raise equity, so firms may opt for debt instead. Thus, market sentiment significantly influences capital structure decisions.