Examkin

Question

Difficulty: MediumTypes and Sources of Business Capital

A public limited company intends to raise long-term capital to finance the construction of a new factory branch. To avoid diluting the ownership and voting control of existing equity holders, which source of capital is most appropriate for the company to issue?

  1. DebenturesAnswer
  2. B
    Ordinary shares
  3. C
    Bank overdrafts
  4. D
    Trade credit

Answer

Debentures provide long-term loan capital without conferring voting rights, thereby funding major capital projects without diluting shareholder control.
Debentures are a primary source of long-term loan capital. Holders of debentures are creditors who receive fixed interest payments and do not possess voting rights at general meetings. Consequently, raising capital through debentures allows a company to fund major long-term capital investments without diluting the ownership equity or voting power of existing shareholders.

Step-by-Step Solution

1
Identify the financial requirement specified in the scenario
The company needs long-term capital to construct a fixed asset (a new factory branch) while preserving existing voting control.
Matching the duration of the finance source with the asset life (matching principle) and protecting ownership rights dictates the appropriate source of capital.
2
Evaluate short-term versus long-term sources of business capital
Bank overdrafts and trade credit are short-term sources used for working capital, so they are inappropriate for long-term factory construction.
Short-term liabilities must be repaid quickly and cannot fund long-term fixed assets.
3
Compare long-term capital options (equity vs. loan capital)
Ordinary shares grant voting rights and dilute ownership control, whereas debentures represent loan capital with no voting rights attached.
Debenture holders are creditors, not owners, so issuing debentures raises long-term funds without altering equity voting power.

Key Concept

Distinguishing between long-term loan capital (debentures) and equity capital (ordinary shares) regarding control and ownership implications.
Estimated Time:1m 0s
Rate this question

Topics

Types and Sources of Business Capital

More questions from this topic