Question

One of your clients, John Browne, is considering different ways to raise money for the expansion of his company’s operations. John is not sure about the advantages of issuing bonds versus issuing common stock. He asks you to explain, in simple terms, the answer to his question.

Post a response as though you are responding to John's question. Include in your post an explanation of:

(1) the advantages and disadvantages of issuing bonds

(2) the advantages and disadvantages of issuing common stock

(3) the basic differences between preferred stock and common stock

Answer 1

(1) ISSUING BONDS

A bond functions as a loan between an investor and a corporation. The investor agrees to give the corporation a specific amount of moneyfor a specified period of time in exchange for periodic interest payments at designed intervals.

CHARACTERISTCS:

(I) Bonds are units of corporate debt issued by companies and securitised as tradeable assets.

(ii) Bond prices are inversely correlated with interest rates, when rates go up, bond prices fall and vice-versa

(iii) Bonds have maturity dates at which point the principal amount must be paid back in full or risk default.

ADVANTAGES:

Let's look some of the ways issuing bonds can be superior to those other ways of raising capital.

(i) Source of cash: For companies in need of extra capital or resources for business operations, issuing bonds is one of the most effective technique to do it, By issuing bonds you get money from investors without making them part owner of the company.You only need to pay interest for letting them use their money and even if they have invested money in your organization, they are still not part of decision making.

(ii) Tax Deductible: Another advantage of bond issuance is related to the interest an issuer has to pay its investrs. This is because the payment of interest is subjected to tax deductions and considered an expense to the company . while this makes it possible to have money for business operations, it also reduces the taxxes that need to be paid.

(iii) Access to Funds: People who prefer issuing bonds over selling stocks say that this lets the company to borrow money only when at a time it is needed. Instead of borrowing from banking institutions, companies can borrow money from investors and onlthe investors y pay lower interest rates. Moreover, the issuing company can decide the period of maturity of the bond .This also gives them control of their debts.

DISADVANTAGES:

(i) Limitations: One of the setbacks of issuing bonds is the limited power or control of the issuer over where the money borrowed will be used. Since the investors want to ensure that the moneywill be used responsibly, there will be limitations placed on the disbursement of the bond , say in the case of a governmental agency that issues the bond . If the money was intended to the construction of bridge, this is where it should go. The bond cannot be allocated for use of another project.

(ii) Repayments: The money invested in bonds need to be repaid on a monthly basis until it matures, in which the issuer need to pay back the principal amount borrowed .As opposed to stocks where the company will not be responsible in case the stocks did not perform well, Issuing bonds means that the issuer will have to come up with the interest payment regularly.

(iii) Liability: Another disadvantage of bond issuance is the obligationof the issuer to pay the investor the interest regardless of the financial status of the company. In stocks, the company is not liable to the investors if the stocks are down unlike in bonds where the issuer has to pay the investor. In addition, the interest rates wil be a deduction to the profit of the company.

(2) ISSUING COMMON STOCKS

Common stocks are ordinary shares that companies issue as an alternative to selling debt or issuing a different class of shares known as preferred stocks. Common stock represent the ownership of a corporation by its stockholders. It allows investors to vote at annualmeetings and to benefit from higher stock prices and dividends.

ADVANTAGES:

(I) Debt reduction: The funds of a company receives from its sale of common stock does not have to be repaid, and there is no interest expense associated with it. Thus, if a company currently has a high debt load , it can issue common stock and use the proceeds to pay down its debt By doing so the company reduces its fixed costs(since interest expense has been reduced or eliminated), which makes it easier to earn profit at lower sales level.

(ii) Liquidity: If company management believes that the business requires cash to see through future down cycles in economy, or other issue that will constrain its cash flow, Issuing common sock is one potential source of needed cash.

(iii) No security will be needed when issuing common stocks compared to loans where assets should be kept as security.

(iv) The common stock can be issued easily because there is ready market for it.

DISADVANTAGES:

(i) Loss of control: When a company issues stocks, it is essentially relinquishing partial control of the company to outside parties.Stockholders now own part of the company, allowng them to vote on certain issues and become a powerful voice in discussion as to how the company is run. whereas before , control of the company was localized to a few owners, it is now widely dispersed among a number of people.

(ii) Asset Disclosure: In most counteries, including the United States, companies that choose to issue stocks must abide by a number of regulations related to the disclosure of financial information.A large amount of information related to the bond as well as corporate assets.

(iii) Takeover Potential: companies that issue many shares of stock face the risk of being takeover.

(iv) Loss Of Value:A company that issues stocks opens itself up to a public evaluation of its value.

(3 ) DIFFERENCE BETWEEN PREFERRED STOCK AND COMMON STOCK:

(i) The main difference between preferred stock and common stock is that preferred stock gives no voting rights to stockholders while common stock does.

(ii) Preferred stockholders have priority over a company's income meaning they are paid dividends before common stockholders.

(iii) Common stockholdrers are last in line when it comes to company assets, which means they will be paid out after creditors, bondholders, and preferred sgtockholders.

(iv) In a liquidation, preferred stockholders have a greater claim to a company's assets and earnings. This is true during company's good times when the company has excess cash and decides to distribute money to investors through dividends .The dividends for this type of stock are usually higher than those issued for commom stock.

(v) Preferred stocks can be converted to a fixed number of common stocks, but common stocks don't have this benefit.

However, both types of stock represent a piece of ownership in a company, and both are tools investors can use to try to profit from the future successes of the company.

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