7. Factors affecting capital structure decisions Aa Aa In making capital structure decisions, financial managers must anticipate the common fears and desires, as well as the conflicting interests and concerns, of the firm's creditors and shareholders. This requires managers to recognize and manage the trade-offs associated with these two financing constituencies. Ideally, financial managers should consider a variety of factors when establishing or changing a firm's capital structure. While the ultimate objective is the maximization of their shareholders' wealth, more immediate operational criteria include the market perceptions of the consequences of the manager's decisions on the firm's long-term viability and solvency, riskiness, and ability to generate cash flows when needed. Review the following two statements, and indicate which one is false and why. Statement 1 The tax deductibility of debt financing provides an incentive to managers for adding financial leverage to the firm's financial structure. Statement 2 Firms with lower levels of profitability or in volatile industries tend to exhibit higher levels of financial leverage in their capital structures. Statement is false because: OFirms with higher profits or stable cash flows are better able to service the interest payments and principal-repayment obligations associated with the increased use of debt financing. O The tax shield created by the deductibility of a firm's interest expense renders the after-tax costs of debt less than the after-tax cost of equity and encourages the use of debt