Question

Characteristic of an ideal capital structure is

• A. Simplicity
• B. Liquidity
• C. Flexibility
• D. All of these

Hint:

To remember the features of an ideal capital structure, you can use the acronym {F-L-I-C-S}: {F}lexibility, {L}iquidity, {I}ncome (Profitability), {C}ontrol, and {S}implicity.

Answer 1

The Correct Option is D

Step 1: Understanding the Question:
The question asks to identify the features or characteristics of an ideal or sound capital structure.
Step 2: Key Concept:
An ideal capital structure is one that maximizes the value of the firm (or shareholder wealth) and minimizes its cost of capital, while also considering other factors like risk, control, and flexibility.
Step 3: Detailed Explanation:
The key characteristics of a sound capital structure include:
- (A) Simplicity: The capital structure should be simple to understand and manage. It should not be overly complex with too many different types of securities, which can create confusion for investors and management.
- (B) Liquidity: The capital structure should ensure that the company has enough liquidity to meet its payment obligations, especially the fixed interest payments on debt and preference dividends. It should not be overly burdened with debt.
- (C) Flexibility: The capital structure should be flexible enough to allow the company to raise additional funds from any source whenever needed, without undue delay or cost. It should not be so rigid that it restricts future financing options.
Other important features include minimizing the cost of capital, maximizing returns, and maintaining control for existing shareholders. Since simplicity, liquidity, and flexibility are all desirable characteristics, the correct answer is (D).
Step 4: Final Answer
Simplicity, liquidity, and flexibility are all characteristics of an ideal capital structure.