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Equity Holders' Last Claim on Assets

The document outlines the key differences between debt and equity, highlighting that debt involves fixed repayment schedules while equity is tied to the firm's performance and has no maturity date. It explains the rights of equity holders versus debt holders, particularly in terms of management voice and claims on income and assets. Additionally, it discusses the tax treatment of interest and dividends, as well as the order of claims in bankruptcy.

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Eman Ahmed
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8 views8 pages

Equity Holders' Last Claim on Assets

The document outlines the key differences between debt and equity, highlighting that debt involves fixed repayment schedules while equity is tied to the firm's performance and has no maturity date. It explains the rights of equity holders versus debt holders, particularly in terms of management voice and claims on income and assets. Additionally, it discusses the tax treatment of interest and dividends, as well as the order of claims in bankruptcy.

Uploaded by

Eman Ahmed
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPT, PDF, TXT or read online on Scribd

Chapter 3

Debt & Equity

© Pearson Education Limited, 2015. 7-1


Differences Between Debt and Equity

• Debt includes all borrowing (loans) incurred by a


firm, including bonds, and is repaid according to a
fixed schedule of payments.
• Equity consists of funds provided by the firm’s
owners (investors or stockholders) that are repaid
subject to the firm’s performance.

© Pearson Education Limited, 2015. 7-2


Table 7.1 Key Differences between Debt
and Equity

© Pearson Education Limited, 2015. 7-3


Differences Between Debt and Equity:
Voice in Management
• Unlike creditors, holders of equity (stockholders) are
owners of the firm.
• Stockholders generally have voting rights that
permit them to select the firm’s directors and vote
on special issues.
• In contrast, debt holders do not receive voting
privileges but instead rely on the firm’s contractual
obligations to them to be their voice.

© Pearson Education Limited, 2015. 7-4


Differences Between Debt and Equity:
Claims on Income and Assets
• Equity holders’ claims on income and assets are
secondary to the claims of creditors.
– Their claims on income cannot be paid until the claims of
all creditors, including both interest and scheduled
principal payments, have been satisfied.
• Because equity holders are the last to receive
distributions, they expect greater returns to
compensate them for the additional risk they bear.

© Pearson Education Limited, 2015. 7-5


Differences Between Debt and Equity:
Maturity
• Unlike debt, equity capital is a permanent
form of financing.
• Equity has no maturity date and never has
to be repaid by the firm.

© Pearson Education Limited, 2015. 7-6


Differences Between Debt and Equity:
Tax Treatment
• Interest payments to debt holders are treated as
tax-deductible expenses by the issuing firm.
• Dividend payments to a firm’s stockholders are not
tax-deductible.

© Pearson Education Limited, 2015. 7-7


Matter of Fact

How Are Assets Divided in Bankruptcy?


• In bankruptcy assets are divided up as follows:
1. Secured Creditors – Secured bank loans or secured
bonds, are paid first.
2. Unsecured Creditors – Unsecured bank loans or
unsecured bonds, suppliers, or customers, have the
next claim.
3. Equityholders – Equityholders or the owners of the
company have the last claim on assets, and they may
not receive anything if the Secured and Unsecured
Creditors’ claims are not fully repaid.

© Pearson Education Limited, 2015. 7-8

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