Advantages and Disadvantages of Equity Finance of Acme - Essay Example

The financing decision of any project is very important to be considered before you reach a conclusion. The capital structure of the firm should be such that the Weighted Average Cost of Capital (WACC) should be less than your expected rate of return of the project in order to make a profitable investment. There are basically two sources of external financing which can further be subdivided.

Debt financing includes bank loans, debentures, overdraft facilities, hire purchases, lines of credit from customers, and leasing. Debt financing means taking out a loan that has to be paid over a certain period of time with interest. There can be short-term (loan is to be repaid in less than a year) or long-term (debt is to be paid in more than a year) debt financing. These are called debt financing because the company is in debt to the bank or any other financial institution and if they go bankrupt example in the case of debentures, then the financial institution has a claim to the remaining assets of the firm.

Equity financing includes the issuance of shares. Shares are units of investment in a limited company be it a public or private limited company. The shareholders are called the owners of the firm as they own a percentage in the firm. Two types of shares can be issued in equity financing, ordinary shares, and preference shares. Advantages and Disadvantages of external financing options. The first and foremost advantage of any debt financing option is that you retain control of the firm.

There is no loss of ownership to any external person. Therefore you can have all the profits and not have to distribute them to anyone. Secondly, using debt financing, the interest you repay on your loan is tax-deductible. This means that it protects part of your income from the taxes and thus lowers your tax liability every year. As there is no ownership loss, therefore you do not have to share the profit of the company with anyone. Therefore all the profit is earned by the owner of the organization.