ACCA FM Syllabus E. Business Finance - Debt or Equity? - Notes ^{1 / 6}

These are the things you need to think about when asked about raising finance - so just put all these in your answer and link them to the scenario. Job done.

Gearing and financial risk

• Equity finance will decrease gearing and financial risk, while debt finance will increase them

Target capital structure

• The aim is to minimise weighted average cost of capital (WACC).

  In practical terms this can be achieved by having some debt in capital structure, since debt is relatively cheaper than equity, while avoiding the extremes of too little gearing (WACC can be decreased further) or too much gearing (the company suffers from the costs of financial distress)

Availability of security

• Debt will usually need to be secured on assets by either:

  a fixed charge (on specific assets) or 
  a floating charge (on a specified class of assets).

Economic expectations

• If buoyant economic conditions and increasing profitability expected in the future, fixed interest debt commitments are more attractive than when difficult trading conditions lie ahead.

Control issues

• A rights issue will not dilute existing patterns of ownership and control, unlike an issue of shares to new investors.

Less or more risk?

• The providers of debt finance face less risk than the providers of equity finance 

  because there is more certainty over the level of their return. 

  As a result debt providers will require a lower level of return on their investment than equity providers.