Following are the factors affecting the choice of capital structure of a company :
(i) Cash flow position : If a company wants to raise debt it must ensure that sufficient cast flows are expected to meet debt obligations. In situation of shortage of cash, company should use more of equity.
(ii) Risk consideration : Use of more debt increases the financial risk of a business. Risk means that a company is unable to meet its fixed financial charges, i.e. payment of interest etc.
Some business has business risk also. It depends upon fixed costs, e.g., rent, salary, etc. higher operating cost result in higher business risk and vice versa.
(iii) Interest Coverage Ratio : ICR refers to the number of times earning before interest and taxes of a company covers the interest obligation. The higher the ratio, the lower is the risk of company failing to meet its interest payment obligations.
(iv) Cost of debt : The company can employ more debt in its capital structure if the interest rate on debt in less or vice-versa.
(v) Floatation costs : Cost of raising funds is called floatation cost. It affects the choice of capital structure of a company as higher the floatation costs, less attractive the source of finance.
(vi) Tax Rate : Interest on debt is a tax deductible expense, Therefore, a higher tax rate makes debt relatively cheaper. So, more debt can be used.