Question

The directors of a company have decided to modernise the plant and machinery at an estimated cost of rupees one crore. State the merits and demerits of issuing equity shares for the purpose.

Answer 1

Equity shares possess four main characteristics:

1. Equity shares are considered 'risk capital' since holders carry the most risk.
2. Equity stockholders receive earnings after paying interest on loans and dividends on preference shares.
3. Holders of equity shares have complete voting rights over the company's management.
4. Equity shares provide permanent capital for the life of the company.

Merits:

1. Equity shares provide permanent capital.
2. No obligation of a fixed return is created.
3. No security is to be given, and no charge is imposed on the company's assets. As a result, loans with asset security can raise additional funds.
4. During periods of high earnings, equity shareholders receive higher returns.
5. Equity share capital lends legitimacy to the company, inspires confidence among creditors, and allows the company to raise loans.
6. Equity shareholders have voting rights.
7. Equity shares appeal to investors of all income levels due to their low face value.
8. Equity shareholders have the 'pre-emptive' right to purchase fresh shares in the company.

Limitations:

1. If there is not enough space for growth, equity capital may stagnate, share values may fall, and the corporation may become overcapitalized.
2. The issue of extra equity shares may reduce existing owners' authority over the firm's management.
3. Raising the full capital through equity shares prohibits trading on equity.
4. Equity shares do not attract investors who want an assured return.
5. There are far too many time-consuming demands related to equity shares, and they cannot be issued during low market conditions.
6. Equity shares are relatively less liquid.