Long Term Sources of Finance

Question 1

Retained Earnings - Features

Answer 1

Internal source of finance. Retained earnings represent the cumulative net income a company has earned over its lifetime that hasn’t been distributed as dividends to shareholders.

Question 2

RE - Advantages

Answer 2

No issue costs, flexible, improves independence

Question 2

Equity Finance - New Shares

Answer 2

Dilutes control, but increases capital permanently

Question 3

RE Disadvantages

Answer 3

May be insufficient, risk of misuse, opportunity cost, over-capitalisation (hostile take over bid)

Question 3

Preference shares Advantages

Answer 3

Fixed dividend, no voting rights, non-mandatory dividends

Question 3

Equity Finance - Preference Shares

Answer 3

Can be redeemable or irredeemable, convertible, or non-convertible. Preference shares are company stock with dividends that are paid to shareholders before common stock dividends are paid out.

Question 4

Preference Shares - Disadvantages

Answer 4

Dividends are not tax deductible, high cost of issuance, lower priority than debt

Question 5

Bonds and Debentures

Answer 5

Bonds and debentures are both debt instruments used by companies and governments to raise capital. The key difference lies in their security: bonds are typically secured by collateral, while debentures are unsecured. This means that in the event of a default, bondholders have a stronger claim on specific assets for repayment, whereas debenture holders rely on the general creditworthiness of the issuer.

Question 6

Bonds and Debentures - More Features

Answer 6

Secured vs unsecured, redeemable vs irredeemable, convertible vs non-convertible

Question 7

Bonds and Debentures Advantages

Answer 7

The interest paid is tax deductible (tax shield effect), no ownership dilution, fixed term for repayment

Question 8

Bonds and Debentures - Disadvantages

Answer 8

Interest is payable regardless of profitability, increases gearing, there is a risk of default, as issuer may fail to make interest payments

Question 9

Loan Stock - Features

Answer 9

Fixed interest loan with a stock as collateral. The loan earns a fixed interest rate, much like a standard loan, and can be secured or unsecured.

Question 10

Convertible Loan Stock

Answer 10

A secured loan stock may also be called a convertible loan stock if the loan stock can be directly converted to common shares under specified conditions and with a predetermined conversion rate