Question

• Identify and discuss the advantages and disadvantages of one type of long-term debt.
• Suggest to management which type of debt should be issued to obtain $5 million. Provide a brief explanation to support your suggestion.

Answer 1

Various sources used to raise capital. Raising long-term debts are one of the most popular methods of raising the fund. Types of long-term debt are

• Bank borrowing: Bank loan based on credit score of the company
• Long term Debt capital: Capital raised from the market by issuing long term bond

Let’s take bonds as one type of long-term debt. Bonds are the instruments which have maturity of more than one year and considered for long term investment. The example of bonds or long-term debt instruments are treasury bonds, treasury notes, corporate bonds, zero coupon bonds etc.

The advantages of using bonds as one type of long-term debt

• The Bonds generally pays fixed rate or a fixed amount of money to its investors so the is considered as secure income investment.
• It has a fixed maturity date.
• The bonds have limited claim on the earning of the company, up to the amount of principal and interest.
• Bond holder get preference in payments over common stockholders of company
• The risk-averse investors prefer to invest into these kinds of instruments.

Disadvantages of using bond as one type of long-term debt

• Bond holders are exposed to various kind of risk like interest rate risk, credit risk, default risk, maturity risk, liquidity risk etc.
• For companies the payment of interest rate is fixed even if company is making losses.
• The bondholders do not have voting rights for the company