Question

Question: Identify the following as either an advantage (A) or a disadvantage (D) of bond financing.

a. Bonds do not affect owner control.

b. A company earns a lower return with borrowed funds than it pays in interest.

c. A company earns a higher return with borrowed funds than it pays in interest.

d. Bonds require payment of periodic interest.

e. Interest on bonds is tax deductible.

f. Bonds require payment of par value at maturity.

Short answer

Answer

1. (A)
2. (D)
3. (A)
4. (D)
5. (A)
6. (D)

Step-by-step solution

Meaning of Bond

A written instrument issued by the issuer to raise funds for a particular period and pay the investors a fixed rate of return is known as a bond.

Identification of advantages or disadvantages of bond financing

1. Bonds do not affect owner control –Advantage (A)

As bond financing does not reflect equity, ownership rights will not get diluted.

2.A company earns a lower return with borrowed funds than it pays in interest –Disadvantage (D)

As it Decreases return on equity, Bond payments are a burden when income and cash flow are low. Equity financing does not require payments.

3. A company earns a higher return with borrowed funds than it pays in interest. –Advantage (A)

It increases its return on equity.

4. Bonds require payment of periodic interest– Disadvantage (D)

If the business's income is low, then the bond's interest payment is a burden for the business entity.

5. Interest on bonds is tax deductible- Advantage (A)

The issuer gets the benefit in calculating the tax because interest on bonds is tax-deductible as it reduces the amount of tax payment of the business entity.

6. Bonds require payment of par value at maturity – Disadvantage (D)

The bond payment at maturity is considered a disadvantage to the business entity if they are running low on profits.