Question

In: Accounting

What are the trade-offs in financing a company by owner versus nonowner financing? If nonowner financing...

What are the trade-offs in financing a company by owner versus nonowner financing? If nonowner financing is less costly, why don’t we see companies financed entirely with borrowed money?

Solutions

Expert Solution

What are the trade-offs in financing a company by owner versus non owner financing?

Ans: To decide between owner financing or non owner financing, we have to look upon certain factors like life cycle of company. If the company is a start up then the company should rely more on equity capital than borrowed capital because the paying capacity of the company is very less.

Non-owned financing trade-off:

Tax   benefits: interest paid on debt financing is deductible but cash flows to equity financing are generally not. The higher the marginal rate, the greater the benefits of debt. The countries with higher marginal tax rates like US should borrow more than the companies in countries with lower marginal tax rates.

Added discipline: borrowing money may force managers to think about the consequences of the investment decisions a little more carefully and reduce bad investments. But there should be separation between managers and shareholders.

If non owner financing is less costly, why don’t we see companies financed entirely with borrowed money?

Bankruptcy cost: the probability of going bankrupt in case of borrowed capital is more. Only the companies with more stable earning should borrow more. Once a company goes bankrupt it has to bear both direct cost and indirect cost.

Loss of flexibility: every time a company borrows money it losses future borrowing capacity. So if a company wants to have borrowed capital in future it has to hold back use less debt financing

Credit rating: borrowed financing affects the credit rating of the company.


Related Solutions

What are the trade-offs in financing a company by owner versus nonowner financing? If nonowner financing...
What are the trade-offs in financing a company by owner versus nonowner financing? If nonowner financing is less costly, why don’t we see companies financed entirely with borrowed money?
What are the trade-offs of empirical research?
What are the trade-offs of empirical research?
In thinking about the benefits and trade offs of conventional versus organic farming, which type of...
In thinking about the benefits and trade offs of conventional versus organic farming, which type of farming do you think is the right choice? Why?
Discuss the potential trade‐offs of development versus sustainability. Are opportunities for development growing or diminishing? Does...
Discuss the potential trade‐offs of development versus sustainability. Are opportunities for development growing or diminishing? Does the internet provide opportunities for development with limited trade‐offs? Provide discussion in a global context.
What best describes the trade offs of pharmaceutical patents?
What best describes the trade offs of pharmaceutical patents?
What are the political, economic, and social trade-offs associated with tourism?
What are the political, economic, and social trade-offs associated with tourism?
What is a trade-off according to Porter? Why are trade-offs important? Why is it essential to...
What is a trade-off according to Porter? Why are trade-offs important? Why is it essential to make trade-offs? Give examples of trade-offs in the airline industry and Taiwan Semiconductor. What are the trade-offs IKEA made compared to traditional furniture retailers. Talk about product design, product variety, in-store service, delivery and store design, flat packs.
1) Every society faces trade-offs. Explain the concept of trade-offs. Give an example. 2) Outline the...
1) Every society faces trade-offs. Explain the concept of trade-offs. Give an example. 2) Outline the various actions the government sector could take to promote growth.
Explain why scarcity leads to trade-offs.
Explain why scarcity leads to trade-offs.
Explain business-level strategies? What is your understanding of Strategic Trade-offs?
Explain business-level strategies? What is your understanding of Strategic Trade-offs? Explain how the economics of scale and learning-curve effects helps to keep the cost low.
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT