Illustrate the comparison between equity and debt, Financial Management

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Illustrate the comparison between equity and debt

Equity and Debt: A Comparison

1. Equity shares don't carry any fixed charges on them. If company doesn't generate positive earnings, it doesn't have to pay equity shares any dividends. This is very much in contrast to interest on debt, which should be paid regardless of the level of earnings.

2. Equity shares have no maturity date - its permanent capital that doesn't have to be "paid back".  Whereas debt has a fixed maturity date and the debt taken has to be paid pack on that date.

3. Equity shares can, at times, be easier to sell than debt.  It appeals to many investor groups since (1) equity shares generally carry a higher expected return than does preference shares or debentures (2) equity shares provide investors with a better hedge against inflation than debentures (3) returns from capital gains on equity shares aren't taxed until gains are realised whereas interest income on debentures is taxed regularly.

4. The sale of new equity shares gives voting rights or even control if stake is high enough, to additional new share owners who are brought into company. Whereas debt and preference share owners don't have any voting rights (but in special conditions).  For this reason, debt is preferred over extra equity financing.  Equity financing is generally avoided by small companies, whose owner managers aren't willing to share control.

5. Use of debt enables the firm to attain funds at a fixed cost while the use of equity shares means that more shareholders will share in firm's net profits.

6. The costs of underwriting and selling equity shares are generally higher than costs of underwriting and selling preferred shares or debt, which puts extra burden on the companies raising resources. Though life and permanency of the equity shares more than compensates for the additional expenses in initial floatation.

 


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