Question

As an entrepreneur, you have met with the external auditors and they have questioned the valuation of the long-term debt and what effect rising rates will have on this accounting category over the next year. What would you tell them? If you were an investor planning to invest in a well -run profitable company, would you pursue an equity purchase or long-term debt (lending)? Explain

Answer 1

Ans:

a.) So the matter is to explain the auditors that how business(assumed company) has valued its long term debt and the effect of rising interest rates of long term debt over next year.

As an entrepreneur i would tell them about the choice of raising debt fund instead of equity. I will explain them that the company has conducted many market surveys and their is a strong market demand of company's products in the upcoming years. Therefore to capture a large market size our company require funds for long term. So because of strong market demand company will have large profits in upcoming years and it will be easy to pay off all debts along with their interests. I will also explain that the company has raised the debt funds after considering all major risks, market demand of product in upcoming years and all other factors such as going concern, risk handling ability, promoters background etc. This strategy will help the company promoters to earn more profit with the stable plan.

b.)  As an investor we consider many factor before we invest. Risk and rewards runs vice-versa. If we expect more return we face more risk. But if there is a choice to invest in a well run profitable company between equity or debt lending i would like to invest in equity fund because in that case it would be comparatively less risky because of continuous profit in the past. That also indicates that company is capable of high future growth which can leads to higher returns than the debt lending and at a low risk.