Question

Bonds are a liability (debt) for a company, stock is equity and therefore, a form of capital. Using the information and terminology in this module and research you complete on your own, determine the pros and cons for a company for issuing bonds and stocks. Assess the following components:

• Advantages
• Disadvantages
• Potential for Earnings
• Risk
• Access to funds
• Tax implications

Answer 1

Solution:-

Following is the analysis of stocks and bonds, looking at their pros and cons as well as assessing them from the point of view of required components:-

Basis	Stocks	Bonds
Advantages (Pros)	1) The capital investment received through Equities is the most long-term source of finance as it is not supposed to be returned back in the lifetime of the company. Therefore, it's very comfortable way of raising funds 2) The dividend payments on equity shares are not compulsory. The company may decide on the basis of profitability and Investment opportunities if it wants to pay a dividend or not 3) Multiple sources to raise equity methods. including IPOs, FPOs, private placement, preferential allotment, venture capital, private equity, etc	1) Low cost of funds as the share of debtholders in profits is limited to fixed interest payments. 2) Easy to refinance, as the company can easily refinance it's existence debt on maturity. 3) Multiple sources available to raise debt, including bank loans, debentures, bonds, term deposits, finance lease, etc
Disadvantages (Cons)	1) High cost of capital as the cost of equity is higher than cost of debt capital 2) High cost of raising funds, including listing fee, merchant bank fee, other IPO expenses, etc 3) If equity funds are being raised through public, the company has to comply with strict compliance requirements of stock exchanges, regulators, etc such as quarterly filings	1) The interest payments have to be made irrespective of the fact if the company is in profits or losses, i.e. notwithstanding the operating performance of the business 2) The debt must be repaid at a fixed maturity which may result in large cash outflow from business of the company can't refinance it 3) The company may not be able to refinace it's debt at the same interest cost as it has now due to changes in benchmark interest rates in the economy
Potential for Earnings	High potential of earnings for the company as no interest is to be paid annually and the company can reinvest its entire profit back into expansion, pushing the earnings growth higher	Lower potential for Earnings and earnings growth for the company as every year a part of operating income must be paid back to debt holders as interest, resulting in lower free cash flow for reinvestment in business
Risk	Low risk as capital is not be repaid and dividend payments are not compulsory	High risk as the interest payments and capital repayments are to be made as per fixed schedule irrespective of the operating situation of the business in those times
Access to funds	Access to funds involves complex and expensive compliance requirements, including listing compliances, regulatory filings, etc. The compliance cost of listing stocks is far higher than compliance expenses incurred in raising debt funds	Easy access to funds with comparatively lesser compliance requirements from regulators, etc
Tax implications	Dividends not tax deductible, which directly impacts the cost of equity	Interest payments tax deductible, which reduces the cost of debt and makes it more attractive