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In general, companies may raise money from internal and external sources.
They can raise money from internal sources by plowing back part of their profits, which would otherwise have been distributed as dividend to shareholders.
Or, they can raise money from external sources by an issue of debt or equity.
When a company issues shares, shareholders hope to receive dividend on their investment.
However, the company is not obliged to pay any dividend.
Because dividend is discretionary, it is not considered to be a business expense.
When a company borrows money by way of debt, it promises to make regular interest payment and to repay the principal original amount borrowed).
If profits rise, the debt holders continue to receive a fixed interest payment, so that all the gains go to the shareholders.debt positively affects returns to shareholders in good times and adversely affects to them in bad times, it creates “financial leverage” (leverage).
An “unlevered firm” uses only equity capital whereas a “levered firm” uses a mix of equity and various forms of debt.
Julius Robert Oketch - an investment and financial analyst at the central bank of Kenya, holds a PhD B.A (Finance), M.B.A (Finance) and Bcom (Finance) and currently pursuing CIFA (Certified Investment and Financial Analyst (E.A.) with extensive university teaching and research experience.
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