11.3 debt and equity financing

Question 1

Debt Finance

Answer 1

• Short-term and long-term borrowing from external sources by a business

Question 2

Advantages of Debt Finance

Answer 2

• Funds are readily available
• Increased funds lead to increased earning and profits
• Tax deduction for interest payments

Question 3

Disadvantages of Debt Finance

Answer 3

• Increased risk if debt comes from financial institutions
• Regular payments have to be made
• Creditors have first claim on any money if the business ends up in bankruptcy

Question 4

Equity Finance

Answer 4

• Internal sources of finance in the business

Question 5

Advantages of Equity Finance

Answer 5

• Does not have to be repaid unless the owner leaves the business
• No interest payments
• Low gearing: uses resources of the owner and not external sources of finance

Question 6

Disadvantages of Equity Finance

Answer 6

• Lower profits and lower returns for the owner
• The expectation that the owner will have about the return on investment