Question

1. Why do you think most firms issue debt instead of only issuing equity? explain.
2. Why do you think a highly profitable firm like Apple (AAPL), with almost $250 BILLION of cash on hands, would issue debt? explain.

Answer 1

Most firms issue debt because the interest paid on debt is tax deductible while dividends paid on equity are not. As a result, a leveraged firm (firm with debt and equity, both) has a lower cost of capital as compared to unlevered firms. Also, since debt is considered less riskier than equity (as its payments are fixed and take priority over shareholders), it costs less to issue debt than to raise funds through issuing equity. Additionally, debt does not dilute ownership in a firm unlike equity.

Apple has been holding most of its overseas profits outside the US, as cash due to the tax obligations if the cash was repatriated. As a result of this, when the company needed funds, it had to issue debt in the domestic market. Before the current US administration's tax reform law, Apple would have had to pay a 35% tax rate if it repatriated overseas profits to the US. The cheaper option was to issue debt as Apple has a low-risk credit rating of Aa1/AA+. Now that the corporate tax rates have been substantially reduced, Apple can repatriate its overseas profits and reduce its debt.