Question

Hello, Please help with a response to the post below. Thank you!

Dear Professor and Classmates,

There are two factors: The present value of the coupon payments and the present value of the par value. The differences between bond and stock: Bond: Value raises and falls depending on interest rates. Interest payments are tax deductible by the corporation, equity is not lost through issuance, and unpaid debt is a liability. Also it can be issued at any time for any reason. Regarding stock, the value rises and falls depending on the value that the stock trades at on any given day, dividends are not tax deductible, stock issuance is based on transference of equity, loss of stock value creates no liability, and it can only be issued once.

Answer 1

The price of a bond is computed as the discounted value of future cash flows. These arise in the form of coupon payments and par value. Since we discount these cash flows, the price of the bond depends upon the interest rates. The writer is right in pointing out that the dividends are not tax deductible while interest payments are. Also equity represents ownership while bonds are a liability.

However I do not agree with the statement that debt can be issued at any time for no reason. It has to be a carefully planned move by the management since it creates debt burden. Equity also can be reissued later and need not be issued only once in the lifetime of a company.