Question

You are in need of funds to expand your corporation, and three alternatives include issuing common stock, issuing bonds payable, and issuing a note payable. Discuss the pros and cons of each of these three choices. Determine the best choice for your corporation and explain why.

Answer 1

1. Common Stock:

a) Pros:

1. One of the best advantages of using common stock for funding is that you do not incur any fixed payment obligations. It means you are basically getting the funds without having to pay any interest or repay any principal amount as opposed to in the case of notes payable or bonds payable.

2. Second advantage from an operational point of view is that it brings diversity and other qualified people into the organization mix.

b) Cons:

1. If you have ever declared a dividend and you fail to pay so, it will very badly hurt the image of the company. Also shareholders do generally expect a good return on their investment through dividends from time to time.

2. Another disadvantage is that ownership gets diluted.

2. Bonds Payable:

a) Pros:

1. One of the biggest advantage of issuing bonds instead of equity is that they do not dilute the value for the existing stockholders.

2. Since bonds are usually issued for a long term, you could easily invest your long-term projects and earn enough return to pay back the bonds and earn a hefty profit at the same time.

b) Cons:

1. The most obvious and feared disadvantage is the fixed interest and principal obligations. These obligations can very easily lead to the dissolution of a company.

2. It has a very bad impact on the cash flows because despite the huge intake of cash flow at once, it affects the working capital cash flow a lot due to fixed interest obligations spread over a number of years.

3. Notes Payable:

a) Pros:

1. As already discussed above, just like bonds, they do not dilute the ownership of the company.

2. There is generally a reduced risk in case of notes payable since long-term note payables usually require fixed interest payments at fixed intervals which can be budgeted and planned.

b) Cons:

1. It is not a solution for the long-term projects. It is usually only meant for meeting the working capital needs.

2. Again fixed payment obligations might put too much of a burden on the company.

In my opinion, the best choice for my corporation would be to obtain the funding through Common Stock because of the following reasons:

1. We have seen many companies become insolvent due to the burden of fixed payment obligations. This is because usually funds are raised through bonds when huge investment for a project is required. And there is always uncertainty as to whether the project will be successful or not. Hence if the project is not successful companies usually don't have any choice other than going bankrupt. However in case of common stock you will never face this problem.

2. I think it's important to bring innovative minds into the organization. An organization can only grow when it learns diversification. I believe diversification and bringing innovative minds into the management of the company is key to growth and future success of the company.