Question

"Balancing the Debt and Equity" Please respond to the following:

Discuss the options for a company to raise funds. Identify at least two (2) reasons that a company might prefer to issue debt rather than equity for tax purposes. Determine how the holders of the instruments view the advantages and disadvantages of holding each instrument. Defend your position.

Answer 1

Answer:	The various options for the company to issue funds can be common stock, Preferred stock, bonds, Long-term and short-term debt etc.
	The two reason that the company prefer debt over equity are (1) Interest on debt is tax deductible. (2)There is no need to give up companies ownership.
	The advantage and disadvantage of each instrument are as follows
	Debt Instrument
	Advantage	Disadvantage
	There is a fixed rate of interest income i.e. interest will be received even in case where company incurrs loss.	Rate of interest is fixed i.e. in case of huge profit also the holder will get interest at rate specified.
	The holder of debt gets preference over equity at the time of liquidation.	High risk for investor if the company has more debt than equity.
	Common Stock
	Advantage	Disadvantage
	Dividend income is tax exempt.	Common stock are paid at last at the time of liquidation.
	The holder gets share in ownership	There is no dividends in case of loss
	Preferred Stock
	Advantage	Disadvantage
	Fixed dividend that must be paid for paying dividend to common share holders.	Preferred stock are paid after payment to creditors at the time of liquidation.
	The holder gets share in ownership	Dividends are paid only if company makes profits.