The purpose of this paper was to determine the relationship between firm size and capital structure decisions on the development of small and medium enterprises (SME’s) in Kenya, with special reference to hotel and lodges in Eldoret municipality .a descriptive survey research was used to carry out the study .Seventy two (72) respondents were sampled the study was guided by the following research questions: what is the relative size of hotel and lodging SME’s in Eldoret municipality, what are the financial source preferences of hotel and lodging SME’s in Eldoret municipality for financing initial investments, financing ongoing operations and financing future investment, What is the relationship between financial source preference and size of hotel and lodging SME’s in Eldoret municipality. Based on the findings, the study established that relationship between firm size and capital structure choice among hotel and lodging SME’s in Eldoret municipality considering self financing as the most preferred source of financing during the initial stages of their operation. Bank credit was most preferred for ongoing operations followed by retained earnings and share capital respectively. Future financing of the firm in hotel and lodging sector favored use of internal sources followed by use of debt. The chi- square test showed that there was no statistical significance in linking firm size and financing initial investments by internal sources, debt and common stock. The researcher concluded that there was a relationship between firm size and capital structure preference. There was hierarchical preference for internal sources, debt and common stock issues. The firms in hotel and lodging sector preferred a mix in equal proportions of short term and long term debt to finance its operations. The researcher drew the following recommendations. First, hotel and lodging operators and entrepreneurs should consider internal financing during the initial and final stages of operations and prefer debt as a second alternative in financing ongoing operations. Second, the government through the tourism board and other donor agencies should consider providing incentives to small and medium enterprises by reducing lending interest rates and increase repayment window period.
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