4.10 ADVANTAGES OF DEBENTURES
It involves less cost to the firm than the equity financing because:
i. Investors consider debentures as a relatively less risky investment alternative and therefore require a lower rate of return.
ii. Interest payments are tax deductible.
iii. The floatation costs on debentures is usually lower than floatation costs on common shares.
(b) Debenture holders do not have voting rights and therefore, debenture issue does not cause dilution of ownership.
(c) Debenture holders do not participate in extraordinary earnings of the company. Thus their payments are limited to interest.
(d) During periods of high inflation, debenture issue benefits the company. Its obligations of paying interest and principal, which remain fixed, decline in real terms.
4.11 DISADVANTAGE OF DEBENTURES
(a) Debentures issue results in legal obligation of paying interest and principal, which, if not paid can force the company into liquidation.
(b) Debenture issue increases the firm's financial leverage and reduces its ability to borrow in future.
(c) Debentures must be paid at maturity and therefore at some point, it involves substantial cash outflows.
(d) Debentures may contain restrictive covenants which may limit the firm's operating flexibility in future.