...Debt versus Equity Financing Brenda L. Rochelle ACC/400 November 7, 2011 Carl Mir Debt versus Equity Financing Introduction In this paper, the author will attempt to compare and contrast lease versus purchase options by providing definitions of debt financing and equity financing and providing examples of each. Additionally, the author will attempt to address which alternative capital structure is more advantageous and why. Business owners must decide whether to purchase outright, finance purchases, or through a long-term lease. Full rights of ownership are realized when purchasing outright. Financed purchases lessen control of the asset by the buyer. Restrictions may be placed on the buyer’s right to sell by the lien holder in an installment purchase. In a long-term lease, the lessee lacks the right to sell, except for any purchase options available. An alternative is short-term leasing. This alternative frees the lessee of most risks of ownership, specifically obsolescence and maintenance. Additionally, the rental rate reflects these advantages. Choosing between outright purchase, financed purchase, long-term lease, and short-term leasing, causes management to face operational considerations such as maintenance, obsolescence, and the degree of control. Decisions involving financial considerations are necessary when ownership is selected. Debt Financing Debt financing is borrowed money a company receives in return for a promise to repay the loan. This...
Words: 515 - Pages: 3
...Debt versus Equity Financing Debt versus Equity Financing Client Letter Accounting Associates 1425 Accounting Dr Chicago, IL 68572 April 18, 2015 John Doe, Chief Administrator XYZ Corporation 123 Somewhere St. Anywhere, USA 12345 Dear Mr. Doe: It was good to see you at the community fund raising event last Saturday afternoon. It is an honor to support this event for our community. In our meeting of February 16, you asked for guidance on the best possible approach in financing capital for your new corporation. There are two alternatives in financing, debt financing, which is borrowing from a lender and equity financing, which is selling of stocks to investors. It would be our recommendation as a start-up corporation to utilize both forms of financing to raise your capital while keeping debt financing to the minimum. In reaching this conclusion we considered the advantages and disadvantages, listed below, of debt financing versus equity financing. We reviewed the Internal Revenue Service’s (IRS) approach on this matter and in consideration of code section 385 which is used to determine if the financing is debt or equity. The IRS may re-characterize debt financing to equity financing under this code section based on the circumstances of the financing (Antebi & Krauthamer, 2014). Advantages of Debt Financing | Disadvantages of Debt Financing | Interest paid is a deductible expense | Reduced cash flow due to monthly payment | Shareholders do...
Words: 771 - Pages: 4
...EQUITY DIVERSIFIED MUTUAL FUNDS V/s DIRECT EQUITY: A comparative study Submitted in Partial Fulfillment for the Degree of Bachelor of Business Studies By Akshat Jain (Roll No. – 08/BBS/7160 Batch: 2008-2011 ) To DEEN DAYAL UPADHYAYA COLLEGE University of Delhi Shivaji Marg, Karampura New Delhi-110015 | | | ACKNOWLEDGEMENT Encouragement motivates a person towards one’s aim while guidance helps one to achieve it. Both encouragement and guidance take one towards success in one’s works. It would be difficult and almost impossible to achieve excellence without the blessings of God above and of elders. I convey my heartfelt affection and accord my deep sense of gratitude to Dr. Deepa Kamra, Faculty Guide for inspiring guidance, constructive criticism, unlimited interest and innovative ideas throughout the pursue of this manuscript. Akshat Jain DECLARATION I Akshat Jain have completed the Summer Training Project titled “EQUITY DIVERSIFIED MUTUAL FUNDS V/S DIRECT EQUITY” under the guidance of Dr. Deepa Kamra in the partial fulfillment of the requirement for the award of degree of Bachelor of Business Studies from Deen Dayal Upadhyaya College, Delhi University. This is an original piece of work & I have neither copied and nor submitted it earlier elsewhere. Akshat Jain Certificate from Internal Guide ...
Words: 9262 - Pages: 38
...Debt vs. Equity Financing ACC 400 May 1st, 2012 Debt vs. Equity financing Many businesses find it necessary to expand. The question is how? Business owners look to the advantages of debt compared to equity. These two categories are the main sources of capital for businesses, which there is nothing more important than raising capital. Finding the right balance between debt and equity financing means weighing the benefits of each and involves accounting, investing, banking and sometimes even some legal assistance. Debt Financing Debt financing is defined as taking on a form of loan/loans that must be repaid over time, often times with interest. In order to use debt financing as an option, businesses can choose to borrow from government agencies or banks for short term; which is usually under a year or long term loan over 12 months. Debt financing has it’s benefits to business owners during tax season because the interest paid on loans is deductible. However, the disadvantage is obviously the risk involved with taking out a loan in general, because there is a burden of that debt and failure to repay that debt with irregular cash flow available. For example: Being a student in college I had to choose if I wanted to invest in my future and how financially I was going to pay my way through school. So I chose to take out loans and pay the interest and loan off while in school, I not only took a risk but I did it to expand and grow. Second example...
Words: 676 - Pages: 3
...ratio is 1.273 vs. 1.847 on December 31, 2012. Current ratio determines whether a company will be able to meet their short-term obligations like paying their creditors and purchasing raw materials for its production and indicating the company’s efficiency. When a company’s current ratio is higher than a 2.0 it indicates that their current assets are larger than their short-term liabilities. When their current liabilities are greater than their current assets making the current ratio less than 1, the company may have trouble meeting their short-term debt obligations. Debt to equity ratio is determined by the long-term debt of a company divided by their shareholder’s equity. On December 31, 2013 Starbucks debt to equity was 0.419 vs. 0.1063 on December 31, 2012. Debt to equity ratio shows a percentage of the company’s assets that were financed by their debt vs. their equity. When companies have a high debt to equity ratio it shows that the company has strongly financed their activities through their debt and have to pay the accumulated interest on the financing which could result in volatile earnings. When there is a low debt to equity ratio it shows that the company have a lower risk due to the fact that the debt holders having less claim to the company’s assets. Return on equity ratio determines the rate of return on money that was invested from common stock owners which is kept by the company for previous years that have been profitable. Starbucks return on equity on December...
Words: 428 - Pages: 2
...regards to raising capital for the business. The main sources for raising capital are through debt and equity. “Debt financing means borrowing money from an outside source with the promise of paying back the borrowed amount, plus the agreed-upon interest, at a later date.” (Palermo, 2014) One of the advantages of debt financing is that the lender does not receive on ownership share to the business because after the debt is paid, there are no more obligations to the lender. Therefore it preserves ownership. Debt financing can be done for small or large businesses and it comes through loans from commercial banks or through organizations like the SBA (Small Business Administration) loan programs. There are disadvantages to this type of financing especially for the businesses that don’t do well and still has the obligation to pay the loan. Instead of all the profits going back into the business, part of it will have to be used to repay the loan. It does not matter if the company is doing well or not, the debt will still have to be repaid monthly or whenever it is due. “Carrying too much debt is a problem because it increases the perceived risk associated with businesses, making them unattractive to investors and thus reducing their ability to raise additional capital in the future.” (Hillstrom, n.d.) Equity is another option my client can take when it comes to raising capital. Equity financing involves the sale of ownership interest through investors to raise funds for the business...
Words: 1067 - Pages: 5
...CHOICE OF MODELS ------------------------------------------------- 1. Discount Models Why FCFF Discount Model? DDM would not be a suitable model because JBH paid dividends which are significantly greater than or lower than FCFE to the firm between 2006 and 2010 thereby underestimating or overestimating the value of JBH (dividends less than 80% of FCFE or greater than 110% FCFE) . The debt to equity ratio has been volatile declining from 82.90% in 2003 to 23.73% in 2010 with a spike of 120.96% in 2006. Estimating future debt issues and repayments will prove to be difficult given that changes are expected because JBH has raised their senior debt facility by $105 million expiring by 2014 possibly to finance the roll out of up to 193 new stores by 2014 as well. The recent stock repurchases of $173 million and possible future repurchases if JBH continues to accumulate cash, will also have significant impacts on leverage. FCFF will certainly be the most appropriate model to apply since debt is not directly considered in determining the cash flow whereas in the FCFE model, the value of net debt issued must be backed out. Furthermore, FCFF refers to cash flows available to investors so recent stock repurchase of $173...
Words: 6977 - Pages: 28
... Cost of Equity * Can be measured with: * CAPM: risk measured relative to a single market factor * Arbitrage pricing model: cost of equity is determined by the sensitivity to multiple unspecified economic factors * Multiple factor model: sensitivity to macroeconomic variables is used to measure risk i. Estimate Risk-Free Rate ii. Estimate Risk Premium iii. Estimate Beta * Unlevered beta: the beta a company would have if it were all equity financed * CAPM: beta estimated relative to market portfolio * APM / Multi-factor: betas relative to each factor have to be measured. There are 3 estimation approaches: * Historical market betas (most used): regressing stock returns against market returns. Analysts often obtain these from estimation services. * Fundamental betas (bottom-up): betas determined by (i) type of businesses the firm in is, (ii) degree of operating leverage (fixed costs relative to total costs), (iii) firm’s financial leverage. * Accounting betas: look at changes in the firms’ earnings vs. changes in earnings for the market. * For private firms, may have to estimate betas using comparable publicly traded firms. * Estimating the cost of equity * Cost of equity is the return shareholders expect to make. If firms don’t deliver this, the SHs become restive and rebellious. * CAPM: Expected return = riskfree rate + beta * expected risk premium * Cost of equity is usually...
Words: 715 - Pages: 3
...global spirits companies. What started as a young salesperson idea to sell top grade whiskey in sealed glass bottles has now flourished in to a company with sales of $3.8 billion dollars (BROWN-FORMAN Our Company, 2012.) The following will contain information on the organizations most recent financial statements. Corporate debt Securities A debt security in finance is when a lender such as a bank or corporation lends money to an interested party looking for financial gain in the form of bonds. Debt securities are interesting because they serve the purpose of creditors who loan money to a borrower and accrue interest to sell them. They have value. For example, a creditor creates a binding agreement with a borrower listing all the financial terms for loan payment in the form of a contract in which will carry value because of the accrued interest attached to it. So with the accrued interest attached, these contracts carry value and now can be sold or even traded; hence debt security (secure debt). This is how creditors secure debt. According to Introduction to Financial Statements reading material, a debt security is also called bonds. Bonds are debt instruments to gain capital. In the Brown-Forman company,...
Words: 1289 - Pages: 6
...current loan in 2012, when the Notes Payable to Accounts Receivable ratio falls back below the 70% threshold. One concern not discussed in the case is the relative growth of Flash Memory vs. the SSD category. Based on the information provided, we estimate Flash’s share of the market at 15% in 2007 which rapidly declines to an estimated 2% by 2013. This underscores Flash Memory’s need to accelerate top line growth to remain a significant player in the market. The forecast balance sheet (Exhibit 2) shows the account balances for Flash Memory assuming they do not invest in the new product line. The financing requirements in 2010, 2011 and 2012 are $14,433, $17,120 and $13,228 respectively. This increase in debt levels has changed the capital structure of the firm over time, increasing debt as a percentage of capital from 28% in 2007 to as high as 39% by 2011 (vs. a target of 18%). We calculated WACC for both scenarios - funding by increasing notes payable or by the issuance of stock. For the notes funding, we assumed a 9.25% cost of debt (loan rate of 3.25% prime + 6%) and a forward looking 2010-2012 average forecast debt/value ratio of 41%, resulting in a WACC of 10.11% (Exhibit 3). For the equity funding, we assumed a 7.25% cost of debt (loan rate of 3.25% prime + 4%) and the target debt-to-capital ratio of 18%, resulting in a WACC of 11.67% (Exhibit 4). The proposed investment would require a substantial cash...
Words: 1026 - Pages: 5
...identify areas of weakness and strength Help creditors to determine creditworthiness Help investors to estimate future cash flows and risk External Users Key Ratios for External Users • • • • • Liquidity ratios Current Ratio Debt management ratios Debt to equity ratio (Leverage) & Times Interest Earned Asset management ratios Inventory Turnover and Average Collection Period Market value ratios Price Earnings Ratio (PE) and Dividend Yield Profitability ratios Gross Profit % of Sales, Net Profit % of Sales, Return on Assets (ROA), Return on Equity (ROE). Interpretation • Liquidity • Solvency • Profitability Ratio Analysis Breakdown Liquidity - Detail Current ratio: Current cash debt coverage ratio: Inventory Turnover : Days in inventory : 2.08 vs 2.41 0.67 vs 0.12 3.8 vs 3.5 96 days vs. 105 days Liquidity - Result As a result, Khol's bests J.C.Penney's based on the following analysis (1) assurance of the ability to pay up the obligations when they are due (2) more successful at paying their liabilities. (3) sells their goods and products faster (4) more efficient method of collecting receivables Solvency - Detail Debt to a total asset ratio: Cash Debt coverage ratio:...
Words: 582 - Pages: 3
...Jacque Final Review Guide 1) Operating Leverage vs. financial leverage: Laurence A high degree of Operating Leverage means that a relatively low change in sales will result in large change in EBIT. If all things are held constant, the higher the firm’s fixed cost the greater its Operating Leverage. In Jacque’s words, this has to do with volatility of the top line. Those firms are usually highly automated, capital intensive, hire highly skilled individuals (read pay them huge salaries), and engage into costly R&D activities. Effects of Operating Leverage on Business Risk: (if all other things held constant) the higher a firm’s Operating Leverage, the higher its business risk. This is because in lower economical cycles, the firm will still be incurring its fixed cost. However, remember that higher risk usually commands for a higher return on investment. Financial leverage is the use of debt to finance the activities of a business. Financial risk is the additional risk put on the shareholder when management decides to finance with debt. The more debt a firm takes on, the more concentrated the business risk on the shareholder because the shareholder is a residual claimant. This results in a higher expected rate of return on the investment by the shareholder. Consequences of an increase in leverage (Leverage ↑): * Expected ROE ↑ * Stockholder risk ↑ * Standard deviation ↑ * Coefficient of variation ↑ 2) Cash-Flow statement and valuation: Natalia ...
Words: 8553 - Pages: 35
...Debt and Equity Financing Paper Organizations funding money in the form of capital for their business can be tedious especially if the risk involved is not properly analyzed well. Organizations must be able to identity if the method of funding their capital is going to contribute to the vision and will also provide enough benefits to satisfy investors and lastly if the weighted average cost will generate future income to the business. Organizations fund their business operations through two main sources of capital called debt financing and equity financing. Each in its own way contributes to the finance of the business. Debt Financing Debt financing takes the form of loans that must be repaid over time, usually with interest. With debt financing businesses can borrow money over a short term or long term period. Banks and government agencies, such as the Small Business Administration (SBA) are the main sources of debt financing that businesses can use. The Small Business Administration (SBA) has a loan guarantee program that allows small and minority-owned businesses to borrow money for various business purposes. This organization does not issue loans, but rather guarantees the loans that will be made under its programs by commercial banks and other lenders. Another example of debt financing is the line of credit. This is a bank loan where a business can draw out funds whenever money is needed in the business. These are usually only available to well-established businesses...
Words: 676 - Pages: 3
...economic benefits or control past events. Tangible assets include plants, machineries, cash, trading stocks, and debtors. Intangible assets include goodwill, patents, copyright and trademark. Deferred debit also an asset. Cause it is treated as an asset to create income in future time. Liabilities: Liabilities are claims against assets that is existing debt and obligations. All business purchase merchandise on credit and borrow money from different sources to conduct their business. For example purchase on account is called account payable. Notes payable, wages payables, sales payable are also called liabilities. And the creditors claim must be paid before owners claims. Owner’s equity: The funds of an organization that have been provided by owners (i.e. its total assets less its total liabilities). The claims of creditors must be paid before owners claims. Owners equity is increased investment by the owners and revenue. And it decreases by the drawings and expenses. For example paid the salary expenses. It decreases owner’s equity. Debt: A sum owed by one person or organization to another is called debt. It can be long term or short term and interest may be incurred. It is a part of liability....
Words: 390 - Pages: 2
...Submitted By:- Ishita Singh S143f0015 DEBT vs. EQUITY Debt vs. equity financing is one of the most important decisions facing managers who need capital to fund their business operations. Debt and equity are the two main sources of capital available to businesses, and each offers both advantages and disadvantages. "Absolutely nothing is more important to a new business than raising capital," Steve Jefferson wrote in Pacific Business News (Jefferson, 2001). "But the way that money is raised can have an enormous impact on the success of a business." DEBT FINANCING Debt financing takes the form of loans that must be repaid over time, usually with interest. Businesses can borrow money over the short term (less than one year) or long term (more than one year). The main sources of debt financing are banks and government agencies, such as the Small Business Administration (SBA). Debt financing offers businesses a tax advantage, because the interest paid on loans is generally deductible. Borrowing also limits the business's future obligation of repayment of the loan, because the lender does not receive an ownership share in the business. However, debt financing also has its disadvantages. New businesses sometimes find it difficult to make regular loan payments when they have irregular cash flow. In this way, debt financing can leave businesses vulnerable to economic downturns or interest rate hikes. Carrying too much debt is a problem because it increases the perceived risk associated...
Words: 892 - Pages: 4
