Equity Funding vs. Debt Financing: American Superconductor Case Analysis

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There are a number of reasons that a company would forgo debt financing in favor of equity. The first is that debt financing increases the risk of the company. The cash flows that the company earns are allocated to debt re-service first, which reduces the amount of funding available to help the company expand. Additionally, there may come covenants attached to the debt that further restrict the ability of management to perform its duties in the manner it would prefer. Thus, the debt's restrictions may cause management to undertake activities that are not in the best interest of the shareholders, simply because those activities are in the best interests of the creditors. Another consideration is that the choice of financing should be aligned with the time frame of the project. For AMSC, if the financing is taken it for general growth purposes, that implies an equity investment is a better choice. If the debt is taken out for a specific project, and the payments on that debt are going to be made from that project's cash flows, then debt financing makes more sense under those conditions. There are some considerations that are specific to debt and equity markets as well. Sometimes, debt financing is relatively expensive compared with equity, and vice versa. When interest rates are high, that implies that while customers might like the high rates, the company is not going to want to pay then, especially if rates are expected to fall. The reverse is true of low rates. AMSC may

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