Question

The Bicol Express food company needs to raise money to finance sales which are growing rapidly. The company is deciding whether to issue corporate bonds, common stocks, or preferred stocks to accomplish this purpose. Answer the following questions; What should the company consider before making this choice? What are the advantages and disadvantages of each of the three options?

Answer 1

The company must consider the following before making a choice:

1. The economic conditions

2. Expectations of the investors

3. Estimates cash flows and ability to bear fixed liabilities

4. Ownership and control

The three options:

1. Common stock:

Pros :

(I) Bet suitable when the economic conditions are bullish

(ii) The company does not have any fixed obligations to pay dividends

(iii) Huge monies can be raised through this mode

Cons:

(I) Dilution of ownership

(ii) Pressure to perform well to ensure return on investment

2. Bonds payable:

Pros:

(I) Suitable when the market conditions are bearish

(ii) No dilution of ownership

(iii) Interest paid is tax deductible

Cons:

(I) Fixed obligation of interest payment even if the company does not make profits

(ii) May include fixed charge on assets and does not permit free usage

3. Preferred stock

Pros:

(I) No dilution of ownership

(ii) Dividend payment is not obligatory

Cons:

(I) Has a fixed life time and must be paid back after that

(ii) Usually dividends accrue if not paid in the year and year