## Three Major Considerations in Capital Structure Planning
The finance manager focuses on three major factors while determining the proportion of funds from various sources:
### 1. Risk
The finance manager designs the capital structure so that risk and cost are the least and existing management control is least diluted.
Two types of risk:
- Business Risk — operational risk, not the primary focus here.
- Financial Risk — the focus in capital structure planning.
Financial Risk is of two types:
| Sub-type | Meaning |
|---|---|
| (a) Risk of cash insolvency | Inability to meet fixed interest/principal repayment obligations |
| (b) Risk of variation in expected earnings available to equity shareholders | Fluctuations in EPS due to leverage |
### 2. Cost of Capital
- Cost is a critical consideration.
- A business should be capable of earning enough revenue to meet its cost of capital AND finance its growth.
- The finance manager must balance cost with risk — debt is cheaper but riskier.
### 3. Control
- Issuing further equity shares automatically dilutes the controlling interest of present owners.
- Preference shareholders can acquire voting rights if dividends are not paid for consecutive years.
- Financial institutions providing loans normally stipulate one or more directors on the Board → reduces management's autonomy.
- Hence, raising loans implies partial surrender of control.
### Secondary Considerations
Besides the above three, also consider:
- Marketability of the issue
- Manoeuvrability and flexibility
- Timing of raising the funds
### Factors for Source & Quantum of Capital (Nov 22 — 2 Marks framing)
| Factor | Application |
|---|---|
| Control | Design so existing shareholders continue to hold majority stake |
| Risk | Financial risk should not exceed tolerable limit |
| Cost | Overall cost of capital remains minimum |