Question

Your corporation needs additional capital to fund an expansion. Discuss the advantages and disadvantages of raising capital through the issuance of stock. Would debt be a better option? why or why not?

Answer 1

Advantages of Issuance of stock (i.e Equity):

1) In case if issuance of stock there is no obligation to fixed rate of dividend.( No compulsion to pay dividend every year)

2) Stock is permanent source of capital to the company and is to be repaid only in case of liquidation.

3) Company need not to create any charge in case of issuance of stock but the same is to be done in case of Debt.

4) In case of increased profits share holders are the real owners they will get the excess dividend.

5) Business with more equity has are less risky when compared to those business with debt. i.e less chance of becoming bankrupt.

Disadvantages of Issuance of stock (i.e Equity)

1) With the issuance of stock to outsiders there is dilution in the ownership of the company( May lose control over the company).

2) As the investors are taking risk the expectation of dividend are high it may lead to higher cost of capital.

3) Investors who desire to invest in safe investments with fixed income will not be attracted for Equity capital.

4) As the stock is not redeemable might result in over capitalisation.

5) As the interest payment is allowed as expenditure under Income tax we might loose that advantage by issuing stock.

When it comes to issuance of debt and stock both the options are equally good. Every option is good in its own way for example

when it comes to debt it will have advantage of low cost and allowed as expenditure in the income tax and no dilution in the ownership of the entity and dis advantages like fixed expenditure even with out any income and requires creation of charge.

When it comes to Stock advantages like no fixed cost and dividend will paid only in case of profits, need not to create any charge on assets of the company, is less risky when compared to debt and disadvantages like Dilution in the ownership, Expectations of high rate of dividend, loss of control in the management.