Question

Discuss the advantage of company issue equity capital (500words)

Fixed Costs Unchanged By Equity Capital

Collateral-Free Financing

Long-Term Financing

Convenant-Free Financing

Do not direct copy paste from google, i need more detail on theses, Thanks

Answer 1

Discuss the advantage of company issue equity capital:

The advantages of issuing common equity can be discussed on the following lines:

1] Fixed Costs Unchanged By Equity Capital:

A firm's fixed costs can be operating and financing.

Operating fixed costs are those relating to non-financing activites such as production, marketing and administration. Such fixed costs could be depreciation of PPE, Salaries of supervisory staff, rent, insurance, advertising etc.

Financing fixed costs are interest payable on borrowings and the preferred dividends. These outflows are called fixed in the sense that they do not vary with earnings made by the firm. They are the same amounts year after year.

In the case of debt, the interest charges are stated by a % in the loan agreement, and that fixed amount has to be paid irrespective of the level of earnings. Hence, it is a fixed expense.

Similarly, preferred dividends are also a fixed amount determined at the time of issuance of the preferred stocks and do not vary from year to year.

In contrast, common dividends which, constitute the return to common stockholders', need be paid only when there are profits and only if, the board of directors thinks so. In other words, there is no commitment to pay a fixed amount as dividend. Quantum of dividends are a matter of financing policy.

So the advantage of common equity is that it does not impose any fixed costs on the company.

2] Collateral-Free Financing:

Borrowings like loans and bonds  are generally secured with collateral assets of the company. It limits the freedom of the company in dealing with those assets when the loan is outstanding. In some cases it can seriously hamper the progress of the company.

In the case of equity, there is no need to give any collateral. The company can use its assets as it deems fit.

3] Long-Term Financing:

As common equity need not be redeemed as a condition, it is long term financing with longest maturity, say perpetual.

In contrast debt is mostly repayable after a period. Hence, a company has to provided funds for the repayment as per the schedule agreed upon.

4] Convenant-Free Financing:

Borrowings are with strings attached. Loan agreements usually contain positive and negative convenants, that are to be observed as long as the loan is outstanding. Those covenants can hamper the freedom of the company in certain respects.

Some of the covenants could be, not to distribute dividends above a certain percentage, to maintain a particular current ratio, not to take further loans, and so on.

In comparison, common equity is issued without any such covenants and the company is free to operate to futher its objectives.

5] Lower risk of bankruptcy:

With borrowings, there is a fixed interest charge and the need to repay the principal. In times of continued stress on earnings and cash flows, the threat of bankruptcy is large.

With equity, there is no threat of bankruptcy.

6] Reserving of debt capacity:

When equity is increased there is more debt capacity which can be used in times when the capital market is down.