Over-capitalization results from raising more money than can be profitably used. This can happen when a company issues too much stock or borrows too much money. When a company has too much capital, it can lead to a number of problems, including:
- Increased costs: A company with too much capital will have to pay interest on its debt, which can be a significant expense.
- Reduced profitability: A company with too much capital may not be able to use all of its resources efficiently, which can lead to reduced profitability.
- Increased risk: A company with too much capital is more likely to take on risky investments, which can increase the risk of financial losses.
To avoid over-capitalization, companies should carefully consider their capital needs before issuing stock or borrowing money. They should also make sure that they have a sound business plan in place to use their capital wisely.
Option A is incorrect because payment of excessive amount for goodwill does not necessarily lead to over-capitalization. Goodwill is an intangible asset that represents the value of a company’s reputation, customer base, and other non-physical assets. If a company pays too much for goodwill, it may have difficulty recovering its investment. However, this does not necessarily mean that the company is over-capitalized.
Option B is incorrect because underestimating the rate of capitalization does not necessarily lead to over-capitalization. The rate of capitalization is the percentage of a company’s assets that are financed by debt. If a company underestimates the rate of capitalization, it may end up with too much debt. However, this does not necessarily mean that the company is over-capitalized.
Option C is the correct answer because raising more money than can be profitably used leads to over-capitalization. When a company raises more money than it needs, it has to pay interest on the debt, which can be a significant expense. Additionally, a company with too much capital may not be able to use all of its resources efficiently, which can lead to reduced profitability. Finally, a company with too much capital is more likely to take on risky investments, which can increase the risk of financial losses.
Option D is incorrect because raising only the money that is needed does not lead to over-capitalization. A company should only raise the money that it needs to finance its operations and growth. If a company raises more money than it needs, it may end up with over-capitalization.