Question

1. Explain the difference between debt and equity
2. What factors affect the return on common stockholder’s equity?
3. Discuss the entity theory rationale for making no distinction between debt and equity
4. Explain the term “treasury stock” and why the companies acquire them

Answer 1

1.Difference between Debt & Equity:

In simple connotation Debt is borrowed money whereas Equity is owner’s capital.

In debt one has to pay timely interest fixed at some percentage as well as to settle the principal i.e the debt funds or monies borrowed at some point of time.

Whereas in case of equity it’s just like owners funds which gets acknowledged in form of dividend payment as and when the management thinks to reward the shareholders further it also enjoys the benefit of capital appreciation.

2.Factors that affects common stockholders’ equity can be multiple such as:

a. management decisions.

b. Company’s policies.

c. Stock market conditions.

d. Government Policies.

e. Rates & Taxes imposed i.e taxes on dividend & capital appreciation.

f. condition of the economy globally as well as individually.

g. condition of Industry or sector as a whole.

3. The rationale of entity theory is that it treats owners as a separate entity and creditors a separate entity. It says owners are not to be accountable for any liability. However, such theory is not accepted by majority and rarely adopted by any except in case of Limited liability company or limited liability partnerships. The dictums under the said theory are hypothetical and not practically implementable in general.

4. Treasury Stock is a bought back stock by the company. Such buying back can be done from the stock market or from the individuals directly. Such bought back stock is then issued back to controlled interest people generally few stakeholders to consolidate the holding in few hands so that better decision can be taken in favour of the company i.e. indirectly reducing the masses (other shareholders ) involvement which might have otherwise became bottlenecks in decision making.