Evaluation Of Debt And Equity Funding

Finance. In order to finance our startup year, we issued stocks and borrowed loan to finance our operation and for safety in case the sales did not go well. Financing using stocks means that we are selling common or preferred stocks to individuals. In return for the money, they get some ownership over the company and its interest. This helps to bring public’s awareness about the company. If the sales suffice, we will pay the debt in the second round.

The company position is strong enough so its better that company should use debt financing instead of equity financing.

There are several factors that guide the choice among debt financing and equity financing such as potential profitability, financial risk and voting control. Equity financing is a method used to obtain capital in order to finance operations, growth or expansion. Sources of equity financing are extremely important. Major sources of equity financial are Retained Earnings, sale of stock, and funds provided by venture capital firms. Profits that are kept and reinvested are called Retained earnings, which is a very attractive source fund due to the savings it provides to the entity by not paying the interests, dividends or underwriting fees related to issuing securities. This source of financing does not dilute ownership, but it

With the three debt instruments in the case, hundreds of millions of dollars would become readily available to the company and be at their disposal. Each of the financing opportunities provides their own money in different forms. Great companies need these different financing ideas to

The effect of financial leverage on the cost of equity is prevalent in the Modigliani-Miller capital structure theory. Since the financial leverage increases the cost of equity, it can be considered one of the disadvantages of borrowing. As shown in Appendix A, the cost of equity, at each debt to capital ratio, increases by 0.1% as the financial leverage increases by 10%. With a higher

In general, the lower the company's reliance on debt for asset formation, the less risky the company is since excessive debt can lead to a very heavy interest and principal repayment burden. This is demonstrated through statistics such as high financial risk, low interest coverage ratios, and high debt ratios. However, when a company chooses to forgo debt and rely largely on equity, as in the case of AHP, the company does so at the expense of a tax reduction effect supplied by interest payments. Thus, a company has to consider both risk and tax issues when deciding on an optimal debt ratio.

debt. The steady cash flow generated by the business, short-term bank loans, and the proceeds of the

Although riskier, debt financing helps company have a better financial structure and because Blaine Kitchenware refuses to do so, we agree that their capital structure and pay out policies are not the most appropriate for the firm.

Firstly, interest on debt is tax deductible, therefore, debt is the least costly source of long-term financing as this is a tax saving for the frim. Thus, creditors or bondholders require a lower return on debt as it is considered a reflectively less risky investment. Secondly, the capital structure of a firm is flexible due to debt financing. Ultimately, bondholders are creditors and they do not have voting rights, hence, they are not involved in decision making and business operations. Additionally, the major advantages of equity finance are as follows. Firstly, the capital provided is to finance the businesses short term needs and future projects. Secondly, the business will not have to pay any additional bank expenses such as interest on loans, thus allowing the business to use the money for business activities. Lastly, investors anticipate that the business will develop thus they help in exploring and executing thoughts. Certain sources, for example, venture capitalists and business angel can bring significant skills, abilities, contacts and experience to businesses and they can also provide expertise advice to businesses (Hofstrand,

There is no universal theory of the debt-equity choice, and no reason to expect one. In this essay I will critically assess the Pecking Order Theory of capital structure with reference and comparison of publicly listed companies. The pecking order theory says that the firm will borrow, rather than issuing equity, when internal cash flow is not sufficient to fund capital expenditures. This theory explains why firms prefer internal rather than external financing which is due to adverse selection, asymmetry of information, and agency costs (Frank & Goyal, 2003). The trade-off theory comes from the pecking order theory it is an unintentional outcome of companies following the pecking-order theory. This explains that firms strive to achieve an

There are two basic ways of financing for a business: Debt financing and equity financing. Debt financing is defined as 'borrowing money that is to be repaid over a period of time, usually with interest" (Financing Basics, 1). The lender does not gain any ownership in the business that is borrowing. Equity financing is described as "an exchange of money for a share of business ownership" (Financing Basics, 1). This form of financing allows the business to obtain funds without having to repay a specific amount of money at any particular time. There are also a few different instruments that could be defined as either debt or equity. One such instrument is stock options that an employee can exercise after so many years with the

From this set of problems, we can see that leverage is good for the firm. Leverage has increased the value of the firm as a whole and increased the price per share. Although the cost of debt increases the firm's risk because it increases the probability of default and bankruptcy, therefore shareholders will require higher rates of return on the equity they provide, debt also provides tax savings. And we can see that in table 4, where we calculated the total value of the firm as the pure business cash flows plus the tax savings. Another reason why debt increases firm value is the fact that it reduces WACC, because the cost of debt is generally lower than the cost of equity. Another option that shareholders can do is using homemade leverage. Shareholders should pay a premium for the shares of a levered firm when the addition of debt increases value.

As negative aspects of debt, e.g. personal tax loss and bankruptcy costs however do exist in reality, Miller (1977) elaborates that leverage will either have no or a negative effect on the firm’s value, hence untaxed firms should favor equity.

If external financing is required, the “safest” securities, namely debt, are issued first. Although investors fear mispricing of both debt and equity, the fear is much greater for equity. Corporate debt still relatively little risk compared to equity because, if financial distress is avoided, investors receive a fixed return.. Thus, the pecking order theory implies that, if outside financing required, debt should be issued before equity. Only when the firm’s debt capacity is reached should the firm consider equity.

Harris and Reviv (1990) gave one more reason of using debt in capital structure. They say that management will hide information from shareholders about the liquidation of the firm even if the liquidation will be in the best interest of shareholders because managers want the perpetuation of their service. Similarly, Amihud and Lev (1981) suggest that mangers have incentives to pursue strategies that reduce their employment risk. This conflict can be solved by increasing the use of debt financing since bondholders will take control of the firm in case of default as they are powered to do so by the debt indentures. Stulz (1990) said when shareholders cannot observe either the investing decisions of management or the cash flow position in the firm, they will use debt financing. Managers, to maintain credibility, will over-invest if it has extra cash and under-invest if it has limited cash. Stulz (1990) argued that to reduce the cost of underinvestment and overinvestment, the amount of free cash flow should be reduced to