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(c) Identify and briefly discuss four factors that influence a firm's decision to issue debt or equity for financing. (8 marks)

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(c) Identify and briefly discuss four factors that influence a firm's decision to issue debt or equity
for financing. (8 marks)

(c) Identify and briefly discuss four factors that influence a firm's decision to issue debt or equity for financing. (8 marks)

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AlysProfessional · Tutor for 6 years

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Four factors that influence a firm's decision to issue debt or equity for financing are: controlling authority and ownership in the company, dilution of ownership that can occur due to equity financing, the inherent costs associated with obtaining funds whether it be where these are related with equity, attracting investors, or under the guise of interest under debt, and finally company's future financial outlook.

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## Step 1: Understand the factors<br />Debt and equity are the two major sources of financing used by companies, and a firm's decision to choose one over the other is influenced by multiple factors. It's pivotal to identify and discuss four primary drifts-like ability and desire to maintain control, concerns about diluting ownership, costs associated with obtaining financing and the future financial outlook for the company. <br /><br />## Step 2: Discussing each factor<br /><br />### Factor 1: Control<br />Equity financing often entails a dilution of ownership control over the enterprise. If a firm issues new equity shares, the ownership is diluted among a larger set of shareholders, which can lead to a loss of control for the existing stakeholders. In contrast, borrowing maintains the company's existing share structure and full autonomy stays with the existing shareholders. <br /><br />### Factor 2: Ownership Dilution<br />Along similar lines, owners may not wish to dilute their equity and the associated potential for future earnings. Every share issued reduces their personal stake in the firm, the profits from which encompass both voting rights and dividends. Therefore, a firm keen to avoid such dilution could favor debt financing.<br /><br />### Factor 3: Cost of Capital<br />The cost of debt is generally lower than the cost of equity. However, unlike equity, debt has to be repaid at a future date. While the interest on debt can be deducted from taxable income which decreases the effective cost of debt, defaulting on debt can lead to bankruptcy whereas equity doesn't need to be paid back in adverse situations. Subsequently, if a firm is confident about their ability of comfortably meeting debt obligations, they may choose debt for finance even it comes with bigger burden on cashflow. <br /><br />### Factor 4: Future Financial Outlook of the Company<br />If a company anticipates sunny days ahead with robust cashflows, it may choose debt because debt payments can be planned and budgeted. Conversely, if a company's financial outlook is uncertain, equity financing can provide the needed funds without the obligation to return the borrowed amount.
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