Question

When a company decides to finance a new project, they can either borrow money via bonds or issue stock. What are the advantages and disadvantages of each option?

Answer 1

Advantages of Equity financing or issuing stocks:
1. The dividends need not be paid regularly by the firm and can be paid as per the requirements or capability of the firm.
2. It can be permanent in nature.
3. Firms can increase or decrease share price by buying back shares or issuing bonus or extra shares.

Disadvantages of Equity Financing:
1, Cost of equity financing is high.
2. Issuing stocks have higher flotation cost as underwriting fees and administrative cost is higher.

Advantages of debt financing:
1. Cost of debt is very low due to the tax benefit it provides.
2. It can be borrowed to the level that it can provide optimum cost of the capital.

Disadvantages of debt financing:
1. It increases risk in the firm. Higher the leverage higher is the risk of default.
2. Higher debt can decrease the rating by credit rating agencies and hence incremental cost of debt might increase.