Question

• • Discussion Question 1: Choose between relying on debt or equity to finance the purchase of a new manufacturing facility for your business. Briefly discuss your reason for your choice and address any advantages, disadvantages and inherent risks, if any, associates with your financing choice.
• • Discussion Question 2: Assume a business issued fifty $10,000, 4% bonds throughout the year. A few bonds were sold for $10,000, a few more bonds were sold for less than $10,000 and the remaining bonds were sold for more than $10,000. Explain the reason some bonds being issued at face amount while other bonds were issued at a premium and discount.

Answer 1

Question 1:

You can finance new manufacturing facility for your business by either debt or equity or any combination of both, the market value of a facility is based on its earning potentials and risk undertaken.

You can prefer equity financing as the company has to pay only if it’s making profit after paying all for all the liabilities so the business do not have the pressure of fixed payment.

The advantages, disadvantages and inherent risks of equity financing are followings -

· The equity stocks have residual claim on the profit of the company as they have claim on the profit of the company after paying all other liabilities like interest to debt, taxes and dividends to preferred stock holder.

· The equity financing has unlimited earning potentials for investors as the residual profit of the firm is distributed among equity shareholders.

· Equity stockholders generally have voting rights in the company so the ownership get diluted.

· Equity stocks do not have a maturity date so company may have to share profit for long term.

Question 2:

The reason that some bonds being issued at face amount while other bonds were issued at a premium and discount are followings-

· If coupon rate is equal to bond’s yield to maturity (market interest rate) then bond sold at par or equal to its face value

· If coupon rate is more than bond’s yield to maturity (market interest rate) then bond sold above par or more than its face value. These bonds issued at a premium and called premium bonds.

· If coupon rate is less than bond’s yield to maturity (market interest rate) then bond sold below par or less than its face value. These bonds issued at a discount and called discount bonds.