CBSE SQP 2026, BS Set 1

Question

Arth Nivesh Limited has a high fixed operating cost. The Finance Manager informs the Chief Finance Officer that, in case the company decides to take a loan, for its future financial needs, its fixed financial cost will also increase leading to an overall increase in cost.

Identify the factor affecting choice of capital structure discussed above.

Identify the factor affecting choice of capital structure discussed above. A). Cost of debt B). Floatation cost C). Risk consideration D). Control

Edvaya · Accepted Answer

The correct answer is Risk consideration. **Risk consideration** is correct.

The company already has **high fixed operating costs** (operating leverage). If it takes on debt, it will also incur **high fixed financial costs** (interest payments = financial leverage). This combination of high operating leverage and high financial leverage creates **high total risk** for the company. If revenues decline, the firm will struggle to cover both operating and financial fixed costs. This risk consideration makes taking on debt inadvisable for companies with already high fixed operating costs.

- **Cost of debt**: Refers to the interest rate at which debt is available.
- **Floatation cost**: Transaction costs of issuing new securities.
- **Control**: Refers to the dilution of ownership control when issuing equity.

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