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

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Solution

Merits of issuing Equity shares by the company are:
(a) Absence fo fixed Liability: The company does not guarantee the rate of the dividend of equity shares, so it has no fixed liability as in the case of debentures. In case of losses, a company does not pay dividends.
(b) No change in assets: Shares are issued without any security or change on assets. In this way, the company procure funds without any charge on its assets or even pledging any security thus equity shares enhances a firm's creditworthiness.
(c) Preferred by adventurous investors: Rate of dividend varies with the amount of profits earned by the company. Dividends may be paid at the very high rate in case of sufficient profits. It is thus preferred, byadventurous investors.
(d) No repayment of liability: Funds raised by the issue of shares need not be refunded. The shareholders can not claim the refund, so the company does not have any liability for the repayment of loans.
Demerits of Equity Shares:
(a) Danger of over capitalisation As the funds are easily available without any charge on the assets and also without any guarantee of the dividend. In this case, there is a possibility of over capitalisation.
(b) Danger of manipulation: The management of the company may declare the dividend at a higher or lower rate. It will cause fluctuations in the value of shares. There is always danger of manipulation.
(c) Uncertainty of dividends The rate of dividend is not assumed even not regular. Investors are thus uncertain about their earnings.

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