Question

Why would a firm ever issue stock or find external sources of equity if it has the opportunity to leverage with debt (i.e. use financial leverage)?

Explore leverage as it related to the financial crisis of 2008/2009 and share what you learned.

Answer 1

Firms prefer to issue stocks or find external sources of equity rather than leverage with debt due to various reasons.

If the funds are raised by means of equity, the company does not have to pay it back. It can use the equity to make profits and issue dividend as and when there is sufficient profits. In the case of debt, the loan has to be repaid according to a pre defined plan irrespective of the cash flow of the firm. The borrowing company has the additional burden of paying interest on the debt which will be an expenditure on the profit and loss account of the company..

During the financial crisis of 2008 - 2009, many of the business establishments with the burdan of heavy debt had to be liquidated since they could not service their debts. Even companies with relatively lesser debt funding found it difficult to pay the interest and loan due to insufficient cash flow.

On the other hand no debt companies had a relatively smooth sail because they were not burdened by interest or loan repayment.