Question

Compare the pros and cons of corporate financing by use of bonds versus stocks.

Is APPLE INC. currently using bonds to finance their opportunities? What is their bond rating? What does this rating tell you about the risk and return from an investor’s point of view?

Answer 1

Capital is the most important resource of an organization in order to expand and grow. Actually, the capital is more important the profitability of the organization especially for the initial part of the business timeline. This is something that keeps the company running.

Capital can be raised in 2 ways either by selling equity or raise it from debt instruments(bonds) Both of them have pros and cons.

There is a concept of pecking order theory which states that the least cost of capital is the retained earning followed by debt and lastly debt. One may wonder that the cost of debt is cheaper than the cost of equity. The reason for so is the tax shield that is offered on the interest on the debt whereas the to raise the equity cost incurred are high.

Once the capital is raised the liability for the organization is more towards the bondholders than the equity holders. This generally leads to conflict between the board, equity holders and the bondholders.

The prime advantage of raising capital through equity is there is no liability of paying back dividends. It upon the board to decide whether to pay dividends from the retained earnings.

Apple INC raised 7 billion USD using bonds. The capital that would be raised through bonds would be used for share buyback. As Apple is sitting on a pile of cash but most of it is outside the US. By entering the bond market the prime advantage that company will get is the tax benefits. The 7 billion USD raised would be used for 300 million USD share buyback.

The rating by S&P Global to the Apple Bonds was AA+. This rating states that the probability of default would be less. The risk would be least and the return would be stable. A better rating means better stability in terms of cash flow and lesser default. The returns may not be that high. A less rated bond would always offer higher returns but the probability of default would be higher.