When a company finances through bonds (debt) instead of issuing common stock (equity), it increases earnings per share (EPS) because bond financing does not dilute ownership, whereas issuing new stock does.
* Impact on Earnings Per Share (EPS):
* EPS formula: EPS=Net Income#Preferred DividendsNumber of Outstanding Shares\text{EPS}
= \frac{\text{Net Income} - \text{Preferred Dividends}}{\text{Number of Outstanding Shares}} EPS=Number of Outstanding SharesNet Income#Preferred Dividends
* Since bond financing does not increase the number of shares outstanding, net income is distributed among fewer shareholders, increasing EPS.
* If the company issues more stock instead of bonds, EPS decreases because the same earnings are divided among more shares.
* Why Bond Financing Affects EPS Favorably:
* Interest on bonds is tax-deductible, reducing taxable income and increasing net profits.
* Unlike dividends, which are paid on common stock and reduce retained earnings, bondholders receive fixed interest payments that do not dilute equity ownership.
* A. Lower shareholder control: #
* Bondholders do not get voting rights, whereas issuing more stock reduces existing shareholders' control.
* This statement would be true for stock financing, not bond financing.
* B. Lower indebtedness: #
* Bonds increase a company's debt obligations, not reduce them.
* If a company uses stock financing instead of bonds, it avoids taking on debt.
* D. Higher overall company earnings: #
* While bonds increase EPS, they do not necessarily increase total earnings.
* The company must pay interest on bonds, which could reduce net income if not managed properly.
* IIA Standard 2110 (Governance): Ensures management selects financing strategies that align with financial stability.
* COSO ERM Framework - Financial Risk Management: Evaluates how financing choices impact shareholder value and risk exposure.
* IFRS & GAAP Accounting Standards on Debt vs. Equity Financing: Explain how bond financing increases EPS compared to issuing new shares.
Step-by-Step Justification:Why Not the Other Options?IIA References: