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:
