Association for Financial Professionals (AFP) Practice Exam

What factors determine the mix of capital in a company?

1. Operating risks and immediate financing needs

2. Current debt costs and management's risk attitudes

3. All of the above

4. Only operating risks and management policies

The correct answer is: All of the above

The mix of capital in a company is influenced by a variety of factors that encompass both operational considerations and broader financial strategies. Selecting "all of the above" as the correct answer acknowledges the complexity of capital structure decisions. Operating risks and immediate financing needs play a critical role in determining how a company chooses to finance its operations. A company with high operating risks may prefer a more conservative capital structure, relying on debt less heavily to avoid financial distress. Conversely, if a company faces immediate financing needs, such as for expansion or working capital, it may opt for more short-term funding solutions, impacting its overall capital mix. Current debt costs and management's risk attitudes are also essential factors. The cost of debt can fluctuate based on market conditions and the company’s credit rating, influencing whether the company leans towards equity financing or additional debt. Management’s risk tolerance will further shape these decisions; risk-averse management might favor equity to shield the company from low cash flows, while risk-tolerant management could prioritize debt to leverage growth opportunities. By encompassing all these dimensions, it becomes evident why "all of the above" is the most comprehensive choice, acknowledging that multiple interrelated factors govern the formulation of a company's capital structure.