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ACCA Applied Skills · Financial Management · Sources of finance and their relative costs

Which of the following is a typical feature of debt finance in the form of loan notes, compared with ordinary share capital, from the point of view of the issuing company?

Interest on loan notes is tax-deductible, which, together with lower risk to the investor, makes debt generally cheaper than equity. Interest is a contractual obligation, loan note holders usually have no votes, and they rank ahead of ordinary shareholders on liquidation.

  1. AInterest is a tax-deductible expense, making debt generally cheaper than equityCorrect
  2. BInterest payments are discretionary and can be omitted without legal consequence
  3. CLoan note holders normally have voting rights at general meetings
  4. DLoan note holders rank behind ordinary shareholders on liquidation

Explanation

Interest on debt is deductible in computing taxable profits, and debt holders face lower risk, so required return and cost are lower than equity. Interest is a contractual obligation, so it is not discretionary. Loan note holders do not usually vote and they rank ahead of shareholders in liquidation.

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