Question

I need 200 words explanation and a fresh answer. Thanks in advance. Be safe.

Jon Baird, the founder of Water boots Inc., needs to raise $500,000 to expand his company's operations. He has been told that raising the money through debt will increase the riskiness of his company much more than issuing stock. He doesn't understand why this is true. Explain it to him.

Answer 1

Solution :-

Yes It is true that the funds raising from the debt is more risky as compared to issuing the stock . Because in case of debt company need to pay fixed interest to the Debt holders even the company earned profit or not . While in case of stock holders company need to pay dividend only in case the company earn profit . To pay interest to the debt holders is a liability of the Company while to pay dividend to the share holders is not a liability . That's why we say debt is a risk asset as compared to stock . Also that's why the debt holders are termed as lenders but the stockholders are termed as owners of the company which is having a right to take part in the management or meetings of the company

But From the point of view of the investor . Debt is termed as less risky as compared to Stock . As in case of liquidation first the money repaid to debt holders after that it is paid to Stock Holders . So the Investors which want to take high risk they invest in stocks while the investors who want to take low risk invests in debt. As the debt having low risk and low return and in case of stock it is having high risk and also high returns.

If there is any doubt please ask in comments .