Business financing and the capital structure Assignment

Business financing and the capital structure - Assignment Example Companies can either decided to use equity or debt or a combination of the both. Whichever source is chosen; the following should be noted: Debt finance is a source that earns a fixed return (interest) to the lender. The interest is fixed at the par value of the debt (face value). This source of finance is ideal to be sought by a company that has a strong base of equity. Debt funding is only available to qualified companies based on credit ratings, and its availability is limited to the value of the security provided (Chandra, 2011). Advantages of Using debt finance – first, the interest charged on the debt is tax allowable. Second, the cost of debt is fixed regardless of the profits made by a company and due to that, under high profits, the cost of debt becomes lower. Third, it does not involve many formalities and due to that, it is suitable when a source of finance is required urgently. Fourth, if the debt is long-term, the amount owing declines with time, thus reduces the repayment burden to the borrower. Fifth, this type of finance does not influence a company’s decision since creditors do not participate in the annual general meeting (Chandra, 2011). Disadvantages of debt finance – first, it can only be invested with the lender’s approval. Second, when used in excess, the creditors might demand a representation on the Board of Directors. The representation might affect a company’s decision-making. Third, it is risky to use it during an economic decline because its usage might send a company into receivership. Lastly, it is only available for specific ventures, thus might affect the flexibility of the company’s investment strategy (Chandra, 2011). Equity capital - it is raised from the public through the sale of ordinary shares. This source of finance is available exclusively to Limited Companies. It is a changeless finance source, as the shareholders cannot review this cash except under liquidation. It is, along these lines,