Question

Compare the cost and benefits of obtaining funds through: bank loan, corporate bond, preferred stock, common stock.

Answer 1

Bank Loan

Advantage of raising fund through bank loans

i) You can keep the control of the company.

ii) Interest is tax deductible

iii) It is temporary

Disadvantage

i) High rate of interest is charged for small business.

ii) Difficult to qualify for a bank loan if the business is small.

Corporate Bond

Advantage

i) It helps to keep the control of the company

ii) Interest is tax deductible

iii) It is flexible as we can issue both se ured and unsecured bond.

Disadvantage

i) Regular payment of interest

ii) Restrictions on bondholder as provided in covenants.

iii) Potential for the value of business share to reduce if the profit declines

Preferred Stock

Advantage of raising fund through preferred stock

i) No dilution of control

ii) It is cheaper than equity finance

iii) It improves the borrowing capacity as it is a part of equity, because debt to equity ratio decreases.

Disadvantage

i) Costlier finance than debt

ii) Not paying dividends will affect the market image because the company is not under any obligation to pay it.

iii) Gets only fixed amount of dividend and no extra profit.

Equity

Advantage of raising fund through equity

i) There is no requirement to pay any interest or dividend and neither the initial investment.

ii) Lower risk of bankruptcy

Disadvantage

i) High cost of finance

ii) Dilution of control in ownership

iii) It is a time consuming process to raise equity.