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If a company issues debentures instead of ordinary shares, how the profitability and solvency of the company will be affected in the coming years?
The profitably would be lower if bonds were issued rather than shares, because there would be interest payable on the bonds (but obviously not on shares).
The solvency would be lower if bonds were issued rather than shares, because there would be higher liabilities.
(However, this would be a very poor question if asked in an exam. This is because at first reading, the above makes it sound as though a company should always prefer to issue shares. This is not necessarily the case at all because although the total profit would be higher with shares, the profits per share (earnings per share) could be lower because of there being more shares in issue). Also, lower solvency is not necessarily a problem provided that there is a sufficient excess of assets over liabilities.)
Thank you for your explanation. So should I include your comment in the answer if this question is asked in an exam? Or should I just give a simple answer?
The way that the exam is formatted, you will not have the chance to comment.
So, if it was to be asked, then the answer is just the first two sentences that I wrote in my previous reply.
The reason that I assed the paragraph in brackets was partly to explain, but also why I would be very surprised if it was actually asked in that way in the exam.
You might be interested to know that this question was actually asked in GCE A-level Accounting exam. (The original question asked students to analyse the impact on liquidity and profitability of the two forms of finance:debentures and shares.)
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