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Financial Management

Notes Preference share capital may be redeemed at a predefined future date or at an earlier stage inter
alia out of the profits of the company. This enables the promoters to withdraw their capital from
the company, which is now self-sufficient, and the withdrawn capital may be reinvested in other
profitable ventures. It may be mentioned that irredeemable preference shares cannot be issued
by any company.

Notes Preference shares have gained importance after the Finance Bill 1997 as dividends
became tax exempted in the hands of the individual investor and are taxable in the hands
of the company as tax is imposed on distributed profits at a flat rate. The Budget for 2000–
01 has doubled the dividend tax from 10% to 20% besides a surcharge of 10%. The Budget
for 2001-2002 has reduced the dividend tax from 20% to 10%. Many companies raised funds
during1997 through this route especially through private placement or preference shares,
as the capital markets were not vibrant.

The advantages of taking the preference share capital route are:
1. No dilution in EPS on enlarged capital base – if equity is issued it reduces EPS, thus
affecting the market perception about the company.
2. There is leveraging advantage as it bears a fixed charge.
3. There is no risk of takeover.
4. There is no dilution of managerial control.
5. Preference capital can be redeemed after a specified period.

3.2.3 Debentures or Bonds
Loans can be raised from public by issuing debentures or funds by public limited companies.
Debentures are normally issued in different denominations ranging from 100 to 1,000 and
carry different rates of interest. By issuing debentures, a company can raise long-term loans
from public. Normally, debentures are issued on the basis of a debenture trust deed, which list
the terms and conditions on which the debentures are floated. Debentures are normally secured
against the assets of the company.
As compared with preference shares, debentures provide a more convenient mode of long-term
funds. The cost of capital raised through debentures is quite low since the interest payable on
debentures can be charged as an expense before tax. From the investors’ point of view, debentures
offer a more attractive prospect than the preference shares since interest on debentures is payable
whether or not the company makes profits.
Debentures are, thus, instruments for raising long-term debt capital. Secured debentures are
protected by a charge on the assets of the company. While the secured debentures of a well-
established company may be attractive to investors, secured debentures of a new company do
not normally evoke same interest in the investing public.
Advantages of raising finance by issue of debentures are:
1. The cost of debentures is much lower than the cost of preference or equity capital as the
interest is tax deductible. Also, investors consider debenture investment safer than equity
or preferred investment and, hence, may require a lower return on debenture investment.

2. Debenture financing does not result in dilution of control.
3. In a period of rising prices, debenture issue is advantageous. The fixed monetary outgo
decreases in real terms as the price level increases.

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