9 - The use of debt finance

As covered in the blog of week 3, there are two methods that companies can raise finance, which are equity and debt. Equity finance is to issue shares by various ways, this means it is more risky compare to debt finance, and expecting a higher return as it requires a higher amount of funds to issue shares. Furthermore, through debt finance companies enable to find it lower cost and cheaper, as it is lower transaction cost and tax deductibility of interests, this means the company use debt finance expects lower returns with less risk.

In a contemporary business environment, there are many companies are using equity to raise their finance as equity finance is earlier to gain funds through issue shares in the stock market. However, there are still a number of companies using debt finance, for example, Japan based company of Sony, Sharp and Panasonic, they has announced that losing over billions due to technological edge and mass appeal and their share prices are also declining since 2009. They are well-known multinational businesses in the worldwide, and also a major employers and exporters in Japan. If these three companies collapse, it will cause a huge effect to Japan economy. Therefore Japanese government requested these three companies to borrow huge amounts of debt funding to keep them afloat.

Doubt these three companies were through equity finance to raise their capital, and the past evidences showed that their share prices has dramatically dropped since 2009, which demonstrates that if these three companies cannot perform well in next few years, the consequence of these companies will  collapse and cause Japan economy to downturn. Although using debt finance although companies need to repay interests of it and may cause a fall in share price, the debts take a number of years which determine it is a low risk compare to equity finance when facing to this situation. Also, debt finance enable to decrease the WACC over the time in order to generate a higher NPV profits as debt finance is cheaper than equity finance. As a result, Sony, Sharp and Panasonic’s share price may suffer an unoptimistic situation when using debt finance, but they may able to take advantages to changes their company’s capital structure.