Question

Need help understanding how to compare and contrast financing with debt vs. equity. Which would be financed?

Answer 1

Debt & Equity both are Sources of Finance, "Debt" involves borrowing money which needs to be repaid, plus interest, while "Equity" involves raising money by selling stake in the company.

DEBT vs EQUITY

1. Dilution of Control: Debt does not dilute the owner's ownership interest in the company whereas, raising Equity Dilutes control.
2. Chargeable in Books of Accounts: Cost of Debt is charge against profits for payment of the agreed-upon interest, and has no direct claim on future profits of the business whereas, profit is earned for Equity.
3. Tax Burden: Interest on the debt can be deducted on the company's tax return, lowering the actual cost of the loan to the company, hence Cost of Debt is Tax deductible.
4. Floatation Cost: Raising debt capital is less complicated because the company is not required to comply with laws and regulations.
5. Repayment: Equity is not repayable, debt must be repaid after certain period.

Finance options depends on Need of Business, Growth Opportunities, Need For Dilution, Leverage Position and many other factors.

• If business is earning good, and sales is above break even level then, source of finance should be debt as debt is cheaper source of finance.
• If Returns are good, business should go for trading on equity by imposing debt.
• If payback period is long, business go for long term equity for financing.

Answer 2

When comparing and contrasting financing with debt and equity, it's important to understand the characteristics and implications of each option. Here's an overview:

1. Debt Financing:

• The company has a legal obligation to make regular interest and principal payments, which can strain cash flow.

• Excessive debt levels can negatively impact the company's creditworthiness and ability to secure future financing.

• Interest payments on debt are tax-deductible, reducing the company's tax liability.

• The company maintains full ownership and control over its operations.

• Debt financing involves borrowing funds from lenders, such as banks, financial institutions, or bondholders, with the agreement to repay the borrowed amount plus interest over a specified period.

• In debt financing, the company does not give ownership rights to the lenders. Instead, they have a contractual obligation to repay the borrowed funds.

• Debt financing typically involves fixed interest payments and a specific repayment schedule.

• Advantages of debt financing include:

• Disadvantages of debt financing include:

2. Equity Financing:

• Dilution of ownership and control as new shareholders are added.

• Shareholders are entitled to a portion of the company's profits, reducing potential returns for existing shareholders.

• The company does not have a repayment obligation, reducing financial risk.

• Equity investors can provide expertise, network, and long-term support to the company.

• Equity financing involves raising capital by selling ownership shares or stocks of the company to investors.

• Equity investors become shareholders and have a claim on the company's profits and assets, as well as voting rights in certain cases.

• Equity financing does not require repayment of invested capital like debt financing.

• Advantages of equity financing include:

• Disadvantages of equity financing include:

The choice between debt and equity financing depends on various factors, including the company's financial situation, growth plans, risk tolerance, and market conditions. Both options have their own advantages and disadvantages, and companies often use a mix of both financing methods based on their specific needs.

The decision on which method to choose for financing depends on factors such as the company's capital structure goals, cost of capital, repayment ability, risk tolerance, and the impact on ownership and control. It is important for companies to carefully evaluate their financial situation, long-term goals, and potential implications before deciding on the optimal financing mix.