Share
Explore BrainMass

Use of debt in capital structure; could it be meaningless?

Why might firms whose sales levels change drastically over time choose to use debt only sparingly in their capital structures? What condition would cause capital structure management to be a meaningless activity?

Solution Preview

Why might firms whose sales levels change drastically over time choose to use debt only sparingly in their capital structures?

Companies with erratic sales patterns would be advised to stay more liquid than companies with a very constant cash flow from sales. If you consider the concept from the standpoint of a cash budget, the company with an even cash flow can more easily project uses of cash. However, a company with uneven cash flows would find it difficult to project.

Some companies with uneven sales and cash flows sell seasonal products and services. In this case, even though the sales are not evenly distributed throughout the accounting cycle, the company would know and understand about the seasonal peaks and could plan accordingly. Seasonal companies are good candidates for debt financing because having debt readily available will smooth out the cash ...

Solution Summary

In a 553 word solution, the response explains the concepts with more than one example for ease of understanding.

$2.19