External Factor Determining Capital Structure

The following external factors must be considered while determining the capital structure of a company:-

1. Nature and Kind of Investors: The success of capital structure largely depends upon the psychological conditions of different types of investors. An ideal capital structure is one that suits the needs of different types of customers. Some investors prefer the security of investment and stability of income, while others prefer higher income and capital appreciation. Thus, shares and debentures should be issued in accordance with the tastes and preferences of all types of customers.


2. State of Capital Market: Conditions of the capital market have a direct bearing on the capital structure of a company. In times of depression, the rate of dividends on equity shares comes down and the possibilities of profit are the least. In such a situation the investors would prefer to invest in debentures and not in equity shares. Thus, debentures should be issued in times of depression. Conversely, during a boom period when people have sufficient funds, any type of security can be issued to raise the requisite funds. Hence, equity shares should be issued during the boom period.


3. Cost of Capital: The issue Capital structure of a company is also affected by the cost of the capital issue. The capital structure should, therefore, be designed in such a way as to minimize the commission payable to brokers, middlemen, and underwriters or the discount payable on the issue of debentures and bonds. Thus, a company should raise funds by issuing different types of securities in such a  way as would minimize the cost of the capital issue.


4. Present Statutes and Rules: Capital structure is also influenced by the statutes and rules prevailing in the country. For instance, if a company's income is taxed at a higher rate then directors would prefer to issue debentures because the amount of interest payable to debenture holders is deducted while computing the company's total income. It is a statutory deduction whereas a dividend is not an accepted deduction. It is evident from the foregoing discussion that devising of a sound capital structure is a difficult task, and requires utmost care on the part of promotors. Thus, while devising the capital structure of a company the above important factors should be borne in mind.

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