1.0  
Introduction

The
case study shows that our company is growing but is in need of funding in order
to successfully grow the business. We have been given a few suggestions of how
to obtain the funds by our Chief Financial Officer including issuing shares,
bonds, or preferred shares. We are tasked with researching on the difference of
each of the financial assets in order to find out which is the most suitable option
for the company. The assignment allows us to apply knowledge learned throughout
the module and should be answered and assessed critically.

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2.0  
Issuing
bonds vs Issuing shares for funding

2.1 Bonds

Bonds
are a fixed income investment
wherein the investor loans money to a business or government organization which
borrows the funds for a distinct period of time at a determined interest
rate. A bond is a debt capital market instrument issued by a borrower, who is
then required to repay to the lender/investor the amount borrowed plus
interest, over a specified period of time (Choudhry, 2001)

When
companies need to raise funds for new projects, continue operations day to day,
pay off debts, etc… They may start issuing bonds to interested parties as
opposed to directly obtaining a loan from the bank. When a company issues the
bond, the company enters into a contract with the investor that states the
interest rate to be paid and a specific time in which the borrowed funds should
be returned.

2.2 Characteristics of Bonds

Par
Value

Par
value or face value is the cost at which the bond was first offered available
to be purchased. This speaks to the measure of cash that a bondholder will get
at the maturity stage, and is likewise the amount that a bond is issued for at
the time that an organization or government first offers them up for sale. The
coupon rate or nominal rate is the interest rate that the issuer agrees to pay
each year (Choudhry, 2001). For example, one investor buys a bond at $1100 and
another investor buys it at a discounted price of $900. When the bond matures,
both the investors will receive the face value of the bond at $1000.

Yield

The
coupon or also known as yield is the rate of interest that the issuing party
agrees to pay its bondholders. Once you buy a bond, you become a lender of
funds and you would generally want a high interest or yield in order to get
back the most of what you can. However, at the same time you can get a higher
yield from a much riskier issuer of bonds. Bond’s yields are also in constant
instability. When a bond’s price rises, its yield drops, and vice versa
(Stanton, 1998). For example, a bond with a yield of 10% on a $1000 bond would
mean that a yearly payment of $100 should be given to the bondholder.

Maturity

The
maturity is the date at which the bond comes due and must be restored to
lenders in full.  The range of maturities
are usually one to five years, with a few bonds maturing in 10 or even 30
years. The maturity of a bond refers to the date that the debt will cease to
exist, at which time the issuer will redeem the bond by paying the principal
(Choudhry, 2001).

 

2.3 Shares

A
share, also known as stock or equity is a kind of security that means
possession in a company and signifies a claim on part of the organization’s
assets and earnings. For example, if an
organization has 1,000 shares of stock and one person owns 100 shares, that
person would own and have claim to 10% of the company’s assets.
There are 2 types of shares:

Preferred shares are shares on which a fixed measure of profit is
paid, after all the working costs, interests, and so forth are paid. Sometimes
when the profit isn’t sufficient to meet alternate costs, even the preferred
shareholders don’t get any returns.

Ordinary shares are owned by investors who get profit simply after the
holders of preferred shares get their share of the profits. Because of this,
only the rate of dividend isn’t settled and it continues to change

 

 

 

2.4 Differences of Bonds and Shares
in obtaining funds

 Even though corporations issue bonds and
shares for the sole purpose of obtaining funds for various reasons such as
expanding, scaling the business, or even meeting business goals. There are
still a lot of differences between them which is why companies have to
carefully choose the most suitable option for them.

Firstly,
issuing bonds instead of shares will not change the ownership of the company to
other shareholders, which means that the owner will still own 100% of the
business.  When you issue bonds, you are asking investors to loan your
company money which means that they are creditors to the company and not
owners. Raising capital by
issuing debt is a frequent practice by firms. A debt contract specifies a
series of interest and principal payments to be made by a firm to debtholders
in return for borrowed funds (Begley & Feltham, 1999). Whenever the company
sells stock, it reduces their percentage of ownership on the business and
selling bonds eliminate this disadvantage all together.

Bond
debts work like any other type of debt. The main sum is an advance and does not
increase taxable income. In the company’s corporate income tax return, they can
deduct the interest paid to bondholders. This results in a lower taxable income
and tax liability. When you offer stock, however, the returns are taxed as an
income. Your company is additionally burdened on the profits you pay to your
investors. This builds your tax liability and taxable income. Dividend
restrictions help reduce wealth expropriation that is not firm value maximizing
(Stolt & Högnelid, 2012).

Thirdly,
bonds have a specified life span which means this allows the company to know in
advance how much they have to pay and will end up paying in interest and
repayment of the original loan. When the bonds reach their fixed maturity date,
the duty to repay the lenders end. This is good for the company because it
means they can obtain funding as well as create a financial plan focused
towards repaying bondholders. When stocks are issued on the other hand, there
is a chance that the shareholders will keep the share of the company forever.
These same shares can be sold to others or just given away to beneficiaries. If
the company wants to buy the shares back, they have to offer the shareholders a
premium on top of the original share price

 

 

3.0  
Discussion
of terms used

3.1
Stock splits

A
stock split, also known as a forward stock split, is a corporate activity in
which an organization separates its current shares into different shares to
raise the liquidity of the shares. A
stock split is simply a superficial change to a security’s price and shares
outstanding (Kalay, 2012). The stock split action increases the numbers of
shares into multiple assets, the total value of these shares remain the same
because the split does not add any real value. The most common stock split is
2-for-1 stock split which means for each share a shareholder owns they get an
additional share. So if a company had 1000 shares before the split, they will
have 2000 shares after the 2-for-1 split.

3.2 Why do organizations split
stocks?

Companies
usually choose to split their stocks when they realize that the price of their
shares are increasing to levels that are very high or way above the price
levels of their competitors. Stock split was usually done by companies that had
seen their share price increase to levels that were either too high, or beyond
the price levels of similar companies in their sector (Agara, 2014).

The main purpose of stock split is to make the
company’s stocks seem more affordable to all investors including the small
investors even though the value of the company has not been affected at all. Stock
split encompasses the technique of psychological pricing (Agara, 2014). When a
stock is split, there is a chance that the share price may increase immediately
after the decrease after the split occurred. Moreover, the stock split will
result in any investor either small or big to believe the stock is more
affordable, they end up buying the stock which boosts the demand for the
company’s shares and result in share prices increasing.

The
table below shows an example of how a stock split works

 

 

3.3 Bonus issues

Bonus
shares, also known as scrip issue or capitalization issue, are additional or
extra shares given to the current shareholders of an organization without any
additional cost, based on the number of shares that a shareholder owns. The issue of bonus shares increases the total number
of shares issued and owned, it does not increase the value of the company (Khan
 & Thoufiqulla, 2013). These are
company’s accumulated earnings which are not given out in the form of
dividends, but are converted into free shares. The most common reason for bonus
issues is to give shareholders collateral when the company is short of funds.
For example, when a company declares a 4:1 bonus issue, a shareholder that owns
200 shares will get 800 shares because for every 1 share, the investor gets 4
for free.

3.4 Why do companies issue Bonuses?

Organizations
issue bonus shares to encourage investors to join in the retail of shares as
well gain an increase in their equity base. When
the companies accumulated huge profits and reserves, and it desires to
capitalize these profits the companies will go for issuing bonus shares (Khan &
Thoufiqulla, 2013). . When the share price of the company is high, it becomes
more challenging for new investors to become shareholders because it is too
expensive. The increment in the number of shares will reduce the price per
share even though the total amount of capital remains the same after issuing the
bonuses.

 

 

 

 

 

 

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