Gerard Marlou M.

Bueno
Investment Analysis and Portfolio Theory
Individual Briefer: Analysis of Portfolio Securities

LONG TERM FINANCING

A DISCRIMINANT ANALYSIS OF THE CORPORATE DEBT-EQUITY DECISION

By Martin, John D and Scott, David F, Jr

I. Highlights of the Readings

“It is not clear-cut whether firms choosing to issue equity should have higher or lower
dividend payout ratios than their debt-issuing counterpart. It could be hypothesized that
those with greater demonstrated profitability would have stronger cash positions
enabling them to payout”

Businessman come across the need for capital for multiple reasons. Aspiring
small businesses may seek funding to grow their business, whereas it might need
funding for expansion, purchase of assets or meeting working capital needs. Whatever
the reasons in, they may face an ongoing need for funding which is generally fulfilled by
deciding whether to finance by debt or an equity. Both have their own advantages and
disadvantages and the funding decision depends on the manager’s judgment and the
company future plans.

Debt is the amount of money owned by the borrowers, it involves borrowing

funds from a lender. It may be someone who is close to you or a financial institutions
such as banks and other finance companies. It is characterized by fixed prepayments
with charged interest against the borrower funds. It advantages enables retention of
ownership, it is flexible, and forecasting expenses are easier because loan payments do
not fluctuate, while its disadvantages involves a level of risk as failure to pay back the
debt can cost the assets pledge as collateral and also affects the credit rating of the
company.

Equity refers to ownership interest, usually it is presented by stocks or securities.

Also it refers to the process of raising funds through the sales of ownership of the
company through shares. It advantages is there is no pressure for repayments of
borrowed funds and no additional cost such as interests, it allows minimization of risk
and losses in the event of business failure as the investors share the losses incurred.
On its contrary, raising equity is demanding and time consuming, it may take several
months to find an investors and it requires additional time to provide regular updates to
the management.

II. Critique

I truly understand and agree with the statement I highlighted above, debt securities
have an implicit level of safety to the business because they give you assurance that
the principal amount that is returned to the lender at the maturity date or upon sale of
the security. Ultimately, the selection of appropriate funding depends on various factor.
For a smaller amount of fund and urgency of cash, debt financing would be a better
option. On the other hand, if the businessman is looking for more than just cash and do
not mind sharing ownership, equity financing could be a better choice.

Determining whether or not an existing investment is appropriate is another type of

case process. It is very similar to the case of marking individual investment
recommendation. You should consider an existing investment analysis if you do now
know what your investment is exactly, or if you are unsure if it is still appropriate for you.
The decision whether to debt-equity can leave a lasting impact on the business.