Question

When a company decides to finance a new project, they can either borrow money via bonds or issue stock. What are the advantages and disadvantages of each option? Explain your reasoning.

Answer 1

1. Advantages of borrowing money for a new project :-

A. No dilution in ownership of the organisation

B. No diversion of profits from stakeholders of the organisation.

C. Interest paid on borrowed money can be claimed as deduction to save profit for tax purposes

D. If project got success by using the borrowing money there will be a capital appreciation to the common stock of the organisation.

Disadvantages of borrowing money for a new project :-

A. Increased in debt equity ratio

B. Burden of fixed payment of interest on the organisation

C. whether the organisation is in profit and losses then need to pay principal and interest on borrowed money.

D. Increase the debt equity ratio leads to reduction in in credibility for future borrowings.

E. If return on investment on new project is less than rate of interest on borrowings then it will be a loss to the organisation.

2. Advantages of issue of common stock :-

A. Common stock can be issued at access on par value of stock.

B. issue of common stock increases the marketability of the stock of the organisation in the secondary markets.

C. No burden of fixed payment it in the form of return on issue of common stock. This is the major advantage against borrowing money.

D. Organisation can decide when to issue dividend on issued common stock.

Disadvantages of issue of common stock :-

A. More dilution in ownership of the organisation

B. more number of common stock in public leads to high volatile in the value of stock

C. Organisation may become over capitalised.

D. issue of common stock has a problem that all the issued common stock may be subscribed or may not be subscribed, if all the issued common stock was not subscribed by the public or any investor the motive behind the issuance of common stock to fund a project will get failed and their organisation may not be able to perform the project.

E. If there is a fear of one subscription of the total issued common stock, then organisation has to enter into underwriting agreement which has an expense of underwriting commission.

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