The Cost of Capital
Companies are taking advantage of the low bond capital rates before the Federal Reserve’s withdrawal of financial support market in June. One reason for such acts by companies is because the value of a firm not dependent on the equity to debt ratio which is mainly used by investors.
Another reason why companies issue corporate bonds is because of the prohibitiveness of the costs involved in borrowing money from the banks (Adams et al, 1999). For this reason, most organizations view banks as the last remedy lenders due to the restrictions laid by banks on corporate loans in form of debt covenants.
Since corporate debt is generally used for longer term debt, taking advantage of the low cost may help companies to save up some money which may be used to for other purposes in the business.
On the other hand, corporate bonds or debts, despite the low cost, must be issued with care and only a portion of the business’ equity may be involved. This is because factors like personal taxes, costs of agents, and bankruptcy costs limit debt financing
A firm can lower the sum of tax bill it pays as well as those paid by the investors by failing to issue bonds (Donaldson, 2000). This is because; the capital gains have always had lower rates of taxes as compared to income interest and dividends rates of tax.
In addition, bankruptcy or financial distress prevents a firm from loading up a debt as this reduces the flow of cash to be paid sooner or later to stock- or bondholders.
Finally is the agency cost in the case of companies where shareholders include managers and outsiders (Donaldson, 2000). In such a case, managers act as agents for the outsiders and may make decision in their own favor and not of the shareholders’.
References
Adams et al, (1999).International Capital Markets. International Monetary Fund. WashingtonDC: USA.
Donaldson, G., & Fox, B., (2000). Corporate Debt Capacity. Beard Books. WashingtonDC: USA.
Is this your assignment or some part of it?
We can do it for you! Click to Order!
