Generally, it is easy for a corporation to raise capital though the issuance of bonds. Bonds are attractive to investors particularly those who have high risk tolerance. Investors most likely prefer bonds than stocks since bonds by its nature, are debt and will have higher claim priority on assets than stockholders in the event of bankruptcy. …
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Merits of raising capital through the issuance of Bonds or through issuance of Stocks
Marvin Appel emphasized that “corporate bonds are debt instruments issued by organizations. And, unlike government which is very least likely to default, there is always risk that a corporate business may not be able to pay its obligations to the bondholders” (10). Matt Evans discussed few advantages of issuing bonds to raise capital for a company’s operations. Some of these advantages are:
1. Interest payments made to bond holders are tax deductible as reflected on the issuing corporation’s income statement;
2. Bond issuances do not dilute earnings per share or decrease control within the company;
3. Usually, cost of bonds issued is fixed; interest and principal do not change within the life of the bond; and
4. Expected return of investment to investors is usually lower than ROI on stocks. For tax purposes, legitimate interest expense payments to banks, financial institutions, and other investors are deductible from income before tax. This will include interest or coupon payments to bondholders of the corporation which issued bonds. This is part of the benefits of using funds from debt financing to augment business performance and the same time paying less tax with respect to the company’s income for a covered period. By issuing bonds, it does not change the control structure of a corporation. Equity holdings of stockholders will remain the same; also the same base for earnings-per-share consideration. On the other hand, Evans also pointed out advantages for a company raising capital through the issuance of stocks. These include: a. Stocks have no fixed payments required to investors; investors will receive return of investment based on profits; b. There is no maturity date on the stocks certificate and invested capital does not have to be repaid within a fixed period; and c. Issuing stocks will improve the credit worthiness of the company. At the company’s standpoint, issuance of stocks to raise capital is the cheapest way to finance business operations contrary to bonds. Unlike bonds, there are no scheduled payments for coupon and bulk of funds upon maturity. Shareholders will get income from their investments through dividends if they opt to hold their stocks for a longer period. By issuing stocks, the generated funds will improve ratios like current ratio, acid-test ratio, and debt equity ratio that are of significant considerations for financial statement users. Moreover, if a company continues to have negative results of operations, the invested capital by the stockholders may be absorbed by the loss. That is why it is regarded as the cheapest way to finance business operations. By its nature, stock holdings are not guaranteed in terms of return of investments. B. Risks of raising capital through the issuance of Bonds or through issuance of Stocks Bonds are debt instruments and usually they are huge fund obligations to pay in the future. Ian Giddy had stated that when a corporation borrows up to its capacity, it loses its flexibility of financing some more future projects through debt financing. “The corporation that is issuing bonds should continue to perform well in business to make profit enough to pay back its obligations on bonds” (Appel 29). If an issuing corporation will default in paying obligations on bonds, it has a negative impact to the organization in different aspects in the bond market and in the industry. It can be regarded that in the company’s perspective, debt financing through bonds is an expensive way of raising capital
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