Southwest Airlines Capital Analysis

2155 words - 9 pages

The amount required by the company is $1 million; either using debt or equity or both equity and debt should be used for raising the required amount. Before making any decision about capital structure, both pros and cons of each method of financing have to be analyzed.

Short-term debt:
Short-term debt is easy to rise and faster to get as the requirements of this loan is significantly less. It requires for less verification and less processing time which is a great advantage of this loan (Finance-blog.eu, 2012). The main drawback of short-term loan is higher interest rate and the repayment tenure. Since the loan tenure is short, it will increase the liquidity problem for the company and it becomes difficult to be repaid within the due date (Www.wahm.com, n.d.).

Long-term debt:
This will enable the company to raise huge amount of funds by issuing bond. The main advantage is that the company is not required to pay principal until maturity time; risk involved in bond issue is less which will reduce the cost of loan (Www.boundless.com, n.d.). Debt financing will not dilute the ownership and any decision related to the company can be made fast without any intervention, company will have more independence to make reinvestment of entire profit earned into the future development of the business (Inc.com, n.d.). In this case, debt holders do not have any claim over the economic profits apart from the interest payment, and debt market is more efficient (Bradshaw, 2013). Fixed amount of interest has to be paid all the time till maturity irrespective of changes in the market interest rate. This will reduce the net income available for the company; single non-payment will result in big problems for the company (Johnston, n.d.). Increase in debt may pose restriction on dividend payments and this increase the disclosure requirements for the company. Increased debt financing indicates about the increase in bankruptcy risk (Bradshaw, 2013).

Common stock:
This is an easy way to raise capital as credit rating is not taken into consideration unlike bond. It is easy to attract more investors to invest in the company and the main advantage in this case is that company does not owe any money to others. Increasing stock price is more advantageous to the business (Johnston, n.d.). It will not increase the financial distress cost of the company, there is no obligation for the company to pay dividend to the shareholders like that of interest payment to debt holders. This will reduce the risk associated with the capital of the company (Bradshaw, 2013).The drawbacks of issuing share is the higher cost involved in the process, reduced independence in business decision making, voting rights of the shareholders will affect the crucial decision making of the company and any problem in the company will directly have impact on the stock price (Johnston, n.d.). Generally, adverse movement in the stock price will have negative impact on the entire organization.

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