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Financing Decisions: Debt vs. Equity

Chapter 4 discusses the financial system that connects savers and borrowers, highlighting the choice between debt and equity financing. It covers various theories related to financing decisions, types of financing options, and international financing risks. Additionally, it introduces special financing techniques such as SPACs and reverse takeovers.

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4 views2 pages

Financing Decisions: Debt vs. Equity

Chapter 4 discusses the financial system that connects savers and borrowers, highlighting the choice between debt and equity financing. It covers various theories related to financing decisions, types of financing options, and international financing risks. Additionally, it introduces special financing techniques such as SPACs and reverse takeovers.

Uploaded by

shreya
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© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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💵 Chapter 4: The Financing Decision

1. What is the Financial System?


 It connects people who have extra money (savers) with people who need money
(borrowers).
 Banks, stock markets, and insurance companies are part of this system.

2. Choosing Between Debt and Equity


 Debt: Borrowing money.
o Cheaper because of tax benefits.
o But risky — you must pay interest no matter what.
 Equity: Selling shares.
o No need to pay fixed interest.
o But you must share profits with shareholders.

3. Theories Behind Financing Choices


 Modigliani and Miller Theory:
o If there are no taxes, it doesn’t matter how a company finances itself.
o With taxes, debt is better because of tax savings.
 Static Trade-off Theory:
o Some debt is good, but too much debt is dangerous.
 Pecking Order Theory:
o First use your own profits, then borrow, and only as a last option issue new
shares.
 Agency Theory:
o Managers might waste money. Debt can control them because they must pay
interest regularly.

4. Types of Financing Options


 Equity: Public offering, private placement, rights issue.
 Debt: Bank loans, bonds, lease agreements.
 Modern Finance:
o Islamic finance (no interest),
o Green bonds (for eco-friendly projects).

5. International Financing
 Companies raise money from different countries.
 Risks: Currency value changes, political instability.

6. Special Financing Techniques


 SPACs (Special Purpose Acquisition Companies): Companies created to buy another
company.
 Reverse Takeover: Private company becomes public without IPO.

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