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

First lets see advantages and disadvantages of issuing stock.

Advantages of Issuing Stock:

Cash for the New Project :

If company doesn't have a good credit rating, it may not be able to borrow the money needed. If company incorporateed for the project, it can issue stock of company as its not able to borrow. This is particularly attractive if company is a start-up with no track record. It can attract investors based on it's potential for profit and growth.

No Debt Repayments :

Issuing stock gives the advantage of not owing any money to investors, because company is not borrowing. company doesn't have to make any payments for the money it raised by issuing of stock. In addition, a rising stock value can increase company's credit rating and make it easier to borrow money in the future. Also, the constant need to justify company's actions to shareholders can give company a sharp focus and profitability.

Disadvantages of Issuing Stock:

Ownership gets reduced (Dilution of control) :

If company issues the stock then new investors becomes the owner of the company accoring to their investment part, it means company give each investor a piece of ownership. and because of that company have to be responsible for its actions and it has to answer to the investors for their actions.

Data may be revealed to competitors :

by issuing stock competitors can buy those stock and they became shareholders and they can demand clarifications and data of the comapny as they are port owners and by that information can be leaked to comapny's competitors.

Dividend Payments :

company have to offer regular dividend to provide enough reward for investors to take a chance on company. If company have agreed to pay dividends, shareholders have a right to those dividends, and if company default on a payment, it could hurt company’s reputation and its stock price.

Now Lets see Advantages and Disadvantages of Borrowing money via Bonds.

Advantages of Borrowing money via Bonds

No Dilution of Control :

When company borrows money via bonds, it agree to pay investors interest in exchange for using their money. Bondholders don't own a piece of company's business and they don't participate in it's decision-making.

Flexibility :

Bonds also offer the advantage of allowing company to borrow money only for the time it will need it. For example, Company can issue one-year, three-year and seven-year bonds. Keeping the bond term as short as possible saves company's money, because it can limit the amount of time company pay interest – although the interest is tax-deductible as an expense for the company. So if project pays back the money in few years company can issue only that period bonds.

Can borrow as many times company needs money

Another advantage of bonds is that company can issue them whenever it needs money. This is in sharp contrast to stocks, which companies typically issue only once, because a second offering of stock tends to dilute the share price due to extra supply.

Disadvantages of Borrowing money via Bonds

Interest Payments

You must pay interest payments on time to bondholders. This differs from dividends, which you only have to pay when you declare one. You pay interest according to a strict timetable. This can create problems with your cash flow. In other words, you may have times when you wish you could use your cash for expansion or to buy assets, but you have to pay the interest on your bonds instead.

Debt on Company's Books

Another disadvantage of bonds is that they increase the amount of debt you show on your books. Investors often look at debt as a factor that makes a company attractive or unattractive. You will eat up a portion of your future profits paying your bond interests. Also, you will need to maintain a good credit rating if you want to issue bonds in the future. Otherwise, you could have to offer high interest rates to attract investors.