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Which of the following sources of finance usually has the lowest cost to the company?
Retained earnings
Loan notes
Preference shares
Ordinary sharesI chose retained earnings since it does not incur any issue costs which is also shown in pecking order theory. However, the correct answer is loan note. Can you please explain why?
Thank you in advance, Iniss.
I agree
Retained earnings usually have the lowest cost to the company. This is because they do not involve any issue costs, as the company already has the funds, and there is no requirement to pay dividends or interest to external financiers.It is earnings that are essentially the profits that the company has generated and chosen to reinvest in the business rather than distribute to shareholders as dividends.
There is a situation were
Loan notes may offer tax benefits because interest payments on debt are tax-deductible, which can effectively reduce the cost of debt.
But this has to be clearly identified in the question.
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