Define the meaning of each letter of “FRICTO,” and give an illustration of each

FRICTO is an acronym summarizing important issues that affect the debt-equity mix decision in practice:

(1) F = flexibility -the impact of alternative financing choices on the firm’s future ability to raise funds in any form required. A company with flexibility will not be shut out of the financial markets nor forced to take a type of financing that is not its preferred choice.

(2) R = risk the impact of alternative financing choices on the risks faced by the firm and its stakeholders. In general, taking on additional debt adds to the risks of creditors and shareholders.

(3) I = income the impact of alternative financing choices on the firm’s income stream. A firm with EBIT above the financing indifference point that increases its debt will increase its earnings per share.

(4) C = control the impact of alternative financing choices on each shareholder’s amount of control of the firm. In general, selling additional shares of common equity will dilute each shareholder’s control.

(5) T = timing the impact of market conditions on alternative financing choices. Financial market conditions often favor one or another kind of financing.

(6) O = other the impact of alternative financing choice on other issues and vice versa. An example is the ability to use collateral to reduce the cost and risks of debt financing.