(a)The debt and equity mix is an example of a financial leverage ratio and indic
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(a)The debt and equity mix is an example of a financial leverage ratio and indicates the extent to which borrowed funds are used to finance assets. What are the main factors that go into determining the right mix of equity and debt? If debt is always cheaper than equity, why have equity? (b)U are the owner of a start-up company that is small, but growing fast. To support your growth, you need to purchase some long-term fixed assets. You are considering whether to buy or lease. Why might a financial lease be especially attractive for your situation?Explanation / Answer
n a debt, you necessarily have to pay interest every year at contracted rate, whether you incur profit or not. A debt carries the burden of repayment on maturity and the risk on debt may occur any time, if business sees downturns. High leverage is not good for any organization. In case of insolvency, the debt will have to be paid if secured, to the extent of realizable value of the security. Debt will get priority over the equity in the event of insolvency. However, in the case of equity you are under no such obligations. Equity represents owners. having more equity adds to company's financial strength. No fixed rate for payment of dividend. No risk of repayment Dividend is payable only if profit is made, then again only when decided by the Board. Plough back is possible. In the case of insolvency, the stake of equity holders comes as last. In distress, it can even be decided to reduce the extent of liability under equity thru sub-division or consolidation. When there is excess profit, bonus shares can be issued or dividend can be paid. 2) Leasing offers several advantages, especially for cash-strapped small businesses planning to acquire technology which tends to be quickly outdated. Leasing offers the ability to free-up working capital and have cash to grow your business. For small business, a main issue in the debate over leasing or purchasing is having enough capital to run and grow operations. Meeting tight payroll deadlines or buying inventory are only two of the very real strains on cash flow. When it comes to putting down a large sum of cash or going to the bank for credit to buy or upgrade equipment, an equipment leasing option can be a better alternative for small businesses. Having cash reserves invested in equipment makes the company asset rich and cash poor. Cash poor companies cannot respond to changing market conditions or take advantage of new opportunities.
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