Question

14.What one advantage does a debt security have over equity security?

Answer 1

Debt and Equity are the popular ways of financing the entity. Debt issue enables the company to pay amount of interest and principal even in cash strapped times.Both of them have their own advantages and disadvantages. Debt security creates an obligation on the company to pay the interest cost which is not such in the case of Equity.

However, there are certain advantages to issuing debt over equity security:

1.The interest payment made on Debt is tax deductible. For example: If we have issued debt for $1,000,000 @ 12%, then we will be paying interest of $120,000 per annum. This payment translates into a tax benefit of $36,000 (if tax rate is 30%). There is no such benefit in equity.

2. Issuing debt raises the obligation to pay interest and principal but There is no dilution in control as compared to equity. In Equity issue, the ownership gets diluted due to additional owners being added every time of issue.