Question

Question 1 Imagine two siblings, Tony and Jack Lee are Malaysia. They need to raise RM3 million ngs, Tony and Jack Lee are planning to set up a company in need to raise RM3 million to get their company off the ground. For many entrepreneurs, especially first-time founders, raising capital can be da Tony has proposed to Jack a few methods to raise capital as following:- 1. Preference shares 2. Debentures 3. Ordinary shares 4. Bank borrowing Required: Explain the different methods to raise capital. Your answer should include the advantages and disadvantages of the methods. [8 marks]

Explain different methods to raise capital. Your answer should include the advantages and disadvantages of the methods. (8marks)

Answer 1

Preference shares are those shares which carry certain special rights. Dividend at a fixed rate is payable on these shares before any dividend is paid on equity shares. At the time of winding up of the company, capital is repaid to preference shareholders before ordinary shareholders. Preference shares do not carry voting rights.

Advantages:

1. A company is not bound to pay dividend on preference shares if its profits in a particular year are insufficient.

2. The rate of dividend on preference shares is fixed.

3. A company can issue redeemable preference shares for a fixed period. The capital can be repaid when it is no longer required in business.

Disadvantages:

1. Dividend on preference shares has to be paid at a fixed rate and before any dividend is paid on equity shares.

2. The preference shareholders get repaid first before equity shareholders when the company gets dissolved.

A company can borrow from the general public by issuing certificates called debentures for a fixed period of time and at a fixed rate of interest.  Debenture holders are the creditors of the company carrying a fixed rate of interest.

Advantages:

1.  Issue of debenture does not result in dilution of interest of equity shareholders as they do not have right either to vote or take part in the management of the company.

2.  Interest on debenture is a tax deductible expenditure and thus it saves income tax.

Disadvantages

1. Payment of interest on debenture is compulsory and it becomes a burden if the company incurs loss.

2.Too much dependence on debentures increases the financial risk of the company as debentures have to be repaid unlike equity shares.

3. Redemption of debenture involves a larger amount of cash outflow.

The holders of ordinary shares are the real owners of the company. They have a voting rights and a say in management of the company. They have a control over the working of the company. Equity shareholders are paid dividend after paying first to the preference shareholders.

Advantages:

1. It is a permanent source of capital and the company has to repay it except under liquidation.

2. Equity shares do not create any obligation to pay a fixed rate of dividend.

3. Equity shares can be issued without creating any charge over the assets of the company.

Disadvantages:

1. If too many shares are issued, the management risks losing control of the company due to diluted ownership.

2. Once issued these cannot be bought back without consent of the shareholders, if the company becomes valuable these shareholders cannot be directly paid off.

Bank borrowing refers to giving of credit by a bank to a client, it has to be paid along with interest in a timely manner.

Advantages:

1. Bank borrowings can be easily procured.

2.  Interest paid on a bank borrowing is a tax deductible expense.

Disadvantages:

1. Bank borrowings have to compulsorily be repaid along with interest thereon.

2. Non repayment of bank borrowings can result in liquidation of the company.