Question

advantages and disadvantages of utilizing debt vs equity in a c corp.both corporate and shareholder

Answer 1

There are different sources of fund available to meet the financial needs of the business. The sources can be equity and debt where debt includes debentures ,long term borrowings or other debt instruments.

EQUITY

Equity can also be referred to as owner's capital where the company raise funds from promoters or from the investing public by way of owner's or equity capital by issuing ordinary equity shares.

  Advantages to the corporate

1. It is a permanent source of finance.

Since such shares are not redeemable,the company has no liability for cash outflows associated with its redemption.

2. Increases the company 's financial base and thus helps to further the borrowing powers of the company.

3. Not obliged to legally pay dividend.

In case of uncertainties dividend payment can be reduced or suspended.

4. Provides security to other suppliers of fund .

Any institution which gives loan to the company would make sure the debt -equity ratio is appropriate to cover debt.

Disadvantages to the corporate

1 .Cost of equity is higher

Since dividends are not tax deductible and flotation cost is higher, the cost of equity is high.

2. Loss of control

Over dependance of equity leads to dilution of control since equity shareholders are owners.

3. Potential conflicts

The diagreement among partners can lead to conflict.

Advantages to the shareholders

1. Transferability of shares

The equity shareholders can easily transfer the ownership of shares to another person.

2. Voting rights

Equity shareholders have the right to vote and express opinion .

3. Higher rate of return

Equity shareholders gets a high return as they undertake high risk as compared to other suppliers of fund.

4. Owner of the company

Equity shares are practically the owners of the company and have potential rights as compared to other suppliers of fund.

Disadvantages to the shareholders

1. High risk

The investors find it riskier because of uncertain dividend payments and capital gains.

2. Issue of new equity reduces EPS

The issue of new equity shares reduced the earning per share of the existing shareholders. Also it reduces the ownership and control of the existing shareholders.

DEBT FINANCING

Debt financing involves borrowing money at a fixed interest .The companies can raise fund by issuing debentures or borrowing.

Advantages to the corporate

1.Has a leveraging advantage

It bears only a fixed charge. Non payment does not force company into liquidity.

2.No dilution of control

There is no dilution of control as debt holders have no right to take decisions.

3.Provides advantage at time of raising prices

The fixed monetary outgo decreases in real time as price level increases.

4. Low cost

Cost of debt is much lower than cost of preference or equity capital as interest is tax deductible.

Disadvantages to the corporate

1. Obligatory payment

Debt interest and capital repayments are obligatory payments even in absence of profit.

2. Huge cash outflows at maturity

Since debts are needed to be paid during maturity, large amount of cah outflow is needed.

3. Enhances financial risk

Even in times of uncertainty, the company is obliged legally to pay interest. So the risk is higher.

4. Needs to have a good credit rating to receive financing.

Advantage to the debt holders

1. Fixed and stable return

Debt holders are entitled to receive the fixed rate of interest irrespective of the financial position of company

2. Priority at time of liquidation

Debt holders enjoys the priority of receiving the principle amount at time of liquidation.

3. Benefits at the time of increased market interest rates.

Disadvantages to the debt holders

1. No voting rights

The debt holders have no right to vote or to participate in the decision making process.

2. No right to share the profits of the company

Even when the company makes huge profits,Debt holders are entitled only to a fixed rate of interest.