Question

1.Explain the diffrence between equity finance and debt finance with example?
By which one sales bonds and stock to rise money ?
Required short answer otherwise not acceptable

Answer 1

1: Equity financing refers to owners funds. There is no obligation to pay back the finance raised at a specific maturity. The company also is not obliged to pay a fixed rate of return on this source of finance. Equity financing increases the credit worthiness of the organization. However equity financing has a higher cost of capital because this source of finance does not receive any tax advantage.

Debt financing refers to borrowed funds. The organization has to pay a certain amount of fixed interest to the investors. The company is also obliged to repay the face value at a specific maturity date. The company receives tax deduction on the interest paid and hence the source of finance has a lower cost of capital.

2: selection between bonds and stock has to be made based upon the requirement of the funds. When a company issues bonds it is obliged to pay a fixed rate of interest to the bondholders. Also the face value has to be repaid at maturity. There is no such obligation in case of finance raised by way of stock. A company which has just started and has not earned much creditworthiness will have to raise money by way of stock. This will be costlier source of finance and the company will have to reduce the powers of the existing shareholders. However a company which has a very high credit standing in the market can raise money by way of bonds at a much lower cost. The company also needs to keep in mind the purpose of finance and the tenure of finance before deciding the source