Question

Business essential edition 12th

chapter 17

Describe two ways that firms raise capital and identify the pros and cons of each method.

Answer 1

Top Two Ways Firms or Corporations Raise Capital are as follow:

1. Debt Capital

Debt capital is also referred to as debt financing.

Advantages of Debt

• No Control to the lender: They don't have any say in how the owner will do this business and run his company.
• Tax Benefit on Payment made with respect to loan: Loan interest is tax-deductible on the opposite the dividend is taxed on the distribution.
• Foreseeable Cash Outflow: Principal and interest payments are agreed in the advance, due to which we are able to map them in the cash flow statement.

Disadvantages of Debt

• Credit Rating Qualification: The company and the owner must have acceptable credit ratings to take a loan.
• Fixed payments to be made: Principal and interest payments must be made on specified dates without fail, even if the business is going through tough times.
• Collateral against loan: Collateral has to be given to get loan for business and this becomes a major factor in loan application rejection.

2. Equity Financing

Raising capital by way of issuing shares, whether preferred or common.

Advantages of Equity

• Less risk exposure: Even in the case of uneven cash flow or unprecedented circumstances, we don't have to pay a fixed payment of interest and principal, since we have to distribute income from the earning od the company.
• Financing without credit qualification: When you don't have an efficient credit position in the market, money can be raised via equity financing, these are most common among startups as they don't have a credit profile to raise debt.
• Investor's long-term outlook: Investment in stocks is to earn dividend and stock value appreciation, which is a long term approach to generate income and in case of equity the investor have the long term outlook.

Disadvantages of Equity

• Cost of equity: Investor is a longer run expect a return on the investment in the company by way of purchasing shares and this is called the cost of raising equity. We have to pay the investor from our earnings and it can be more than the rate of debt in best result years.
• Sharing of control: The owner gets liquidated when raising funds via equity financing, the owners is reduced by the number of shares issued which directly result in sharing of control with an investor and involvement in the running of the business.