It is the financing decisions that affects the overall cost of capital and financial risk for the enterprise. The following are two of the factors affecting this decision.
1. Cost: Different sources of funds involve different costs. Normally, those sources of funds are opted which prove to be cheapest.
2. Cash flow position: A strong cash flow position implies that debt is more viable than equity and vice-versa.
3.Risk
The risk associated to each of the source is different. The source which involves least risk should be preferred.
4.Floatation Cost
If the floatation cost, i.e. the expenses incurred in issue of debt is higher, the source of finance becomes less attractive.
5.Fixed Operating Cost
If a firm is having a higher fixed operating burden like payment of interests, premiums, salaries, rent, etc, then it should avoid financing through debt. This is because it will further increase the interest payment burden and the firm can reach an unfavourable position. However, if the firm has lower operating cost, then the firm can borrow funds.
