question_answer

Surya Ltd is manufacturing steel at its plant in India. It is enjoying a buoyant demand for its products as economic growth is about 7% to 8% and the demand for steel is growing. Therefore, it is planning to set-up a new steel plant to take benefit of such trends in demand. It is estimated that such an expansion will require about Rs. 5,000 crore to set-up and about Rs. 500 crore of working capital. As the finance manager of the company, state any three factors that would be considered while determining the capital structure for the new venture.

Answer:

In this case, the various factors that are considered in determining the capital structure for the new venture will be: (i) Cost of Debt If the rate of interest on debt is high, the company should use less debt in its capital structure, and vice-versa. (ii) Cost of Equity When a company increases debt, the financial risk faced by equity shareholders increases. Thus, debt can be used upto a limit. Beyond that point, cost of equity may go up and share prices may decrease. (iii) Interest Coverage Ratio ICR refers to the number of times earnings before interest and tax covers the interest obligation. Higher the ICR, the company can borrow more funds and vice-versa.