Discuss the main factors which a company should consider when determining the appropriate mix of long-term and short-term debt in its capital structure.

Discuss the main factors which a company should consider when determining the appropriate mix of long-term and short-term debt in its capital structure.

(i) Matching
The traditional view is that fixed assets should be financed by term sources of
finance and current assets by a mixture of long-term and short-term sources

(ii) Cost –he company may find it easier to raise short term finance with
low security than long term finance

(iii) Security –The company may find it easier to raise short term finance with
low security than long term finance

(iv) Risk –In opting for short-term debt, the company faces the risk that it may
not be able to renegotiate the loan on such good terms. Long term loans are
thus less risky

(v) Flexibility –Short term debt is more flexible since it allows the firm to react
to interest rate charges and avoid being locked into an expensive long term fixed
rule commitment when rates are falling.

---

marto answered the question on February 11, 2019 at 08:02

Exams With Marking Schemes

• Grade 1
• Grade 2
• Grade 3
• Grade 4
• Grade 5
• Grade 6
• Grade 7
• Grade 8
• Grade 9
• PP1
• PP2
• Playgroup
• Form 1
• Form 2
• Form 3
• Form 4

Related Questions

• P. Muli was recently appointed to the post of investment manager of Masada Ltd. a quoted company. The company has raised Sh.8,000,000 through a rights issue. P.... (Solved)
  

  P. Muli was recently appointed to the post of investment manager of Masada Ltd. a quoted company. The company has raised Sh.8,000,000 through a rights issue.
  P. Muli has the task of evaluating two mutually exclusive projects with unequal economic lives. Project X has 7 years and Project Y has 4 years of economic life. Both projects are expected to have zero salvage value. Their expected cash flows are as follows:
  
  The amount raised would be used to finance either of the projects. The company expects to pay a dividend
  per share of Sh.6.50 in one year's time. The current market price per share is Sh.50.
  Masada Ltd. expects the future earnings to grow by 7% per annum due to the undertaking of
  either of the projects. Masada Ltd. has no debt capital in its capital structure.
  
  Required:
  (a) The cost of equity of the firm.
  (b) The net present value of each project.
  (c) The Internal Rate of return (IRR) of the projects. (Rediscount cash flows at 24% for project X and 25% for Project Y).
  (d) Briefly comment on your results in (b) and (c) above.
  (e) Identify and explain the circumstances under which the Net Present Value (NPV) and the Internal Rate of Return (IRR) methods could rank mutually exclusive projects in a conflicting way.

  Date posted: February 11, 2019 .    Answers (1)

• The management of Afro Quatro Ltd. want to establish the amount of financial needs for the next two years. The balance sheet of the firm as... (Solved)
  

  The management of Afro Quatro Ltd. want to establish the amount of financial needs for the next two years. The balance sheet of the firm as at 31 December 2001 is as follows:
  
  For the year ended 31 December 2001, sales amounted to Sh.240,000,000. The firm projects
  that the sales will increase by 15% in year 2002 and 20% in year 2003.
  The after tax profit on sales has been 11% but the management is pessimistic about future
  operating costs and intends to use an after-tax profit on sales rate of 8% per annum.
  The firm intends to maintain its dividend pay out ratio of 80%. Assets are expected to vary
  directly with sales while trade creditors and accrued expenses form the spontaneous sources of
  financing. Any external financing will be effected through the use of commercial paper.
  
  Required:
  (a) Determine the amount of external financial requirements for the next two years.
  (b) (i) A proforma balance sheet as at 31 December 2003.
  (ii) State the fundamental assumption made in your computations in (a) and b(i) above.

  Date posted: February 11, 2019 .    Answers (1)

• Highlight four advantages and disadvantages to a company of being listed on a stock exchange. (Solved)
  

  Highlight four advantages and disadvantages to a company of being listed on a stock
  exchange.

  Date posted: February 8, 2019 .    Answers (1)

• Explain fully the effect of the use of debt capital on the weighted average cost of capital of a company. (Solved)
  

  Explain fully the effect of the use of debt capital on the weighted average cost of capital of a company.

  Date posted: February 8, 2019 .    Answers (1)

• Rafiki Hardware Tools Company Limited sells plumbing fixtures on terms of 2/10 net 30. Its financial statements for the last three years are as follows: (Solved)
  

  Rafiki Hardware Tools Company Limited sells plumbing fixtures on terms of 2/10 net 30. Its
  financial statements for the last three years are as follows:
  
  Required:
  (a) For each of the three years, calculate the following ratios:
  Acid test ratio, Average collection period, inventory turnover, Total debt/equity, Net
  profit margin and return on assets.
  (b) From the ratios calculated above, comment on the liquidity, profitability and gearing
  positions of the company

  Date posted: February 8, 2019 .    Answers (1)

• Define agency relationship from the context of a public limited company and briefly explain how this arises. (Solved)
  

  Define agency relationship from the context of a public limited company and briefly
  explain how this arises.

  Date posted: February 8, 2019 .    Answers (1)

• What economic advantages are created by the existence of: (i) Primary markets. (ii) Secondary markets (iii) Portfolio management firms (Solved)
  

  What economic advantages are created by the existence of:
  
  (i) Primary markets.
  
  (ii) Secondary markets
  
  (iii) Portfolio management firms

  Date posted: February 7, 2019 .    Answers (1)