Question

When a company issues bonds, what is one disadvantage it faces by using bonds for long-term financing?

A: Income to stockholders may increase as a result of trading on the equity.
B: Bond interest is deductible for tax purposes.
C: The bondholders do not have voting rights.
D: Interest must be paid on a periodic basis regardless of earnings.

Answer 1

An essential disadvantage a company faces when issuing bonds is the obligation to pay interest periodically regardless of its financial performance, potentially straining the company's cash flow if earnings are insufficient.

Step-by-step explanation:

When a company issues bonds, it faces several potential disadvantages as part of using bonds for long-term financing. The correct answer to the student's question is D: Interest must be paid on a periodic basis regardless of earnings. This disadvantage means that companies are obligated to make interest payments and cannot defer them even if the company's income is low or the business is experiencing financial difficulties. In contrast to issuing equity (stock), where the company is not required to make dividends, bond payments are fixed and must be paid as agreed upon in the bond issuance terms.