- This topic has 2 replies, 2 voices, and was last updated 1 year ago by
.
- Posts
Dear tutor!
I hope that you are doing well.
My question is:
Suppose I am financial manager for company A. I manage the issuing of 10,000 shares. Now, the equity shareholders will receive dividends from any surplus funds available at the end of the year. If there are no or minimal funds available, the shareholder may not get a dividend at all.
On the contrary if someone has bought loan notes from the company, we are bound to repay the whole amount at the culmination of designated time period and also pay them annual interest.
So isn’t debt finance costing us more in comparison to equity finance?
I don’t understand how debt finance (raising money for the business through issuing loan notes) is cheaper than equity finance ?
Thank you in advance!
The complete sentence is: Financing of the company via equity alone is not consistent with maximising shareholder wealth, since it deprives shareholders of the benefits of debt finance, which is cheaper than equity.
Maybe they mean that it is cheaper to avail debt finance like buying loan notes is cheaper for financiers in comparison to buying shares in a company??
Is my assumption correct?
Your assumption is correct. Debt finance, such as buying loan notes, is generally cheaper compared to buying shares in a company.
This is because debt lenders require a lower return than equity investors due to the lower risk associated with debt investments.
Additionally, debt interest is tax allowable to the company, providing further cost advantages.Therefore, financing a company solely through equity without utilising debt finance would not be consistent with maximising shareholder wealth, as it would deprive shareholders of the benefits of cheaper debt finance.
- You must be logged in to reply to this topic.