S. Legal, 2008). This is primarily due to the fact that unlike equity issues, they do not dilute shareholder's equity or suppress share price. Debt issues are typically conducted with financial institutions only, rather than the markets. However, debt issues have several disadvantages. Debt is an obligation that must be paid. The obligation is both short-term (interest payments) and long-term (principle repayment). However, the payment of this obligation is tax-deductible, as it is in classified as an operating expense. This means that debt has an inherent tax advantage (Richards, no date), one of the main reasons why the cost of debt is typically lower than the cost of equity. There are other disadvantages to debt as well. Debt issues typically require collateral and/or restrictive covenants. For a greenfield investment, the firm would have to post existing fixed assets as collateral, not the new factory. Any restrictive covenants can impact management's ability to run the company as they see fit.
There is a third financing option, mezzanine, but this is of limited appeal to our firm and is typically geared towards entrepreneurs. This form of financing is essentially debt without collateral. Very high interest rates are used by the lender to manage the risk. This is not appropriate for firms with better, less costly, financing options available to them.
When considering whether to issue debt or equity in order to finance this venture, we must consider the firm's financial position in terms of both liquidity and capital structure. We must also consider how best to match the inflows from the project with the outflows for servicing the project. Other factors should also be considered, such as the current interest rates and the expected direction of future interest rates.
It is also worth considering that...
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