Question

State any three advantages of debenture issue as a source of finance.

Discuss the advantages of raising finance through debentures.

Answer 1

1. Appeal to Cautious Investors: A large amount of finance can be raised by the issue of debentures from cautious and orthodox investors who prefer the safety of investment and a fixed return. In tight money conditions, debentures are the best source of finance.
2. Regular Return: Debentureholders are paid interest at a fixed rate and at periodical intervals, irrespective of profits. Therefore, debentureholders are free from the risk of fluctuations in the company's earnings.
3. Safety of Investment: Debentures are usually secured by a charge on the company's assets. Therefore, their repayment is assured.
4. Economical Source: A company can raise funds through debentures at a relatively low cost. This is because investors consider debentures a safe investment. Debentures can be sold more easily than shares. Underwriting commission, brokerage and other expenses of issue are lesser.
5. Freedom of Management: Debentures do not carry voting rights. Therefore, a company can raise funds without diluting or weakening the control of the existing members. The management retains its independence as there is no interference from debentureholders.
6. Trading on Equity: Interest on debentures is paid at a fixed rate. After payment of interest, the remaining profits are available to shareholders. When the earnings of the company increase, the rate of dividend on equity shares can be increased. This is known as trading on equity.
7. Flexibility: A company can repay the funds raised through debentures when it does not require the funds any more. The facility of redemption avoids the danger of overcapitalisation and keeps the financial structure flexible. Funds are available for a fairly long period and can be repaid out of earnings.
8. Tax Relief: Interest paid on debentures is allowed a deduction while calculating taxable income. It results in savings in income tax liability.