What are the advantages and disadvantages of using debt in a firm's capital structure? Advantage/Disadvantage a. A distribution of stock to shareholders can be a nontaxable stock dividend while a distribution of a debt usually results in dividend income. b. Interest is deductible (subject to limitations) by the payor while a dividend payment is not deductible. c. Repayment of an indebtedness generally is treated as a return of capital while a stock redemption generally is treated as a dividend. d. Stock can be received tax-free as part of a corporate formation and/or reorganization while the receipt of debt usually is treated as boot. e. Worthless stock results in an ordinary loss under Sec. 1244 while a worthless debt instrument generally results in a capital loss.

a. Disadvantage

b. Advantage

c. Advantage

d. Disadvantage

e. Disadvantage

Explanation:

Debt refers to a mode of raising long term finance whereby the borrower, usually a corporate agrees to repay periodic interest and at the same time principal repayment upon maturity.

Debt is an obligation whereby the interest obligation must be met by the borrower irrespective of it's profits.

One advantage of debt financing being, interest paid on debentures and bonds is tax deductible.

Issue of common stock meanwhile confers members with voting rights and ownership rights. Stockholders are paid dividend and the company pays their principal lastly, after having met all other obligations.

Issue of common stocks lead to dilution of control and at the same time, dividend unlike interest is not tax deductible.