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The financing decision

The capital structure decision –

practical factors to consider

1.1 Debt or equity finance? – Practical factors to consider

Alongside the investment decision and the dividend decision, the financing decision
is one of the key decisions that the financial manager will have to make.

The key issue is what mix of equity and debt finance should make up a
company’s capital structure.

The following practical factors should be considered:

 cost of the different sources of finance (k d < k e)

 current capital structure (also called gearing level)

 availability – availability of finance depends on the
creditworthiness of the borrower and also the willingness of
lenders to extend credit (for bank borrowings) or liquidity of the
capital markets (for equity and bonds)

 impact of different financing options on the financial statements,
tax position and financial stakeholders of the company

 liquidity implications – the ability of the business to service the new
debt, allocating sufficient cash resources to meet interest and
capital repayment obligations

 duration – for how long is finance required?
 lending restrictions – for example security and debt covenants

 the currency of the cash flows associated with the new project

 views of key stakeholders – for example, customers may be
concerned about buying goods from companies that have high
gearing and poor credit ratings, and employees might choose to
leave if they fear for their job security

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