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In: Finance

Write a 500-word memo to the CEO explaining the pros and cons of issuing new stock,...

Write a 500-word memo to the CEO explaining the pros and cons of issuing new stock, reissuing treasury stock (if applicable), and issuing convertible bonds. In addition, include your recommendations on how the company could generate cash from issuing new common stock, preferred stock, convertible bonds or reissuing treasury stock. Support your recommendations with examples that show the impact on cash.

Solutions

Expert Solution

To: The CEO

Subject: Pros and Cons of issuing stocks and bonds.

A company can use different sources of finance to raise capital. The generated capital can be for various purposes like access to increased cash flow, paying debts or growing the business. Company can use debt or equity to raise funds. Equity holders are the owners of the company while bond-holders are the lenders.

Common stock are ordinary shares which a company issues to raise capital instead of using debt.

Pros of Issuing stocks:

  • Stock holders are liable only to the amount invested.
  • Control is with board of directors who are chosen by the stockholders.
  • Good source of rasing money.

Cons:

  • Dilution of ownership: For example if a company has $60 million shares and sells $15 million shares to raise money, it gives up 25% ownership in the company.
  • Many legal regulations.
  • Rick of Takeover: For example if a company issues $60 million shares and someone purchases $31 million shares hence their ownership becomes more than 51% and they become majority owner of the company.

Other variants of stocks and hybrid istruments:

Treasury Stocks are stocks which the company can buyback and reissue later to raising capital just like common stocks. But treasury stocks has less rights, like these are not entitled to dividend and do not have voting rights.

Convertible bond is a bond which can be converted into the common stock of the company. When such bonds are converted to stocks, it eliminates that portion of company's debt.

Disadvantage: Dilution of ownership.

Preference shares is a hybrid instrument which has features of both stock and bonds. These are issued to raise capital while keeping debt of the company low and and not diluting control, as preference share holders do not have voting rights.  

Disadvantage: costly, has preferential rights: For example in case of bankruptcy preference shareholders have first right to receive dividends.


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