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Companies throughout the world issue new stock shares every day. But, what is stock
and why does a company issue it? To help you to better understand these important concepts
in this tutorial we will discuss:
Let us begin by defining the word capital.
WHAT IS CAPITAL?
Let's imagine that you decide to start up your own ice cream shop business.
You will need to invest in equipment, food supplies and property. All the money that
you invest to start your business is called capital. Essentially, the capital of a business
consists of all of its assets (or items to assist in the creation of wealth).
What if it dawns on you that you don't have enough cash to buy all the needed assets?
Let's see how new businesses and companies deal with this problem.
EQUITY vs DEBT
To start a new business (or fund a new project) a company can raise money in two ways - by selling
shares of equity or by incurring debt. If the owner of our ice cream parlor invested all
their own savings to buy the materials necessary to start the business, they made an equity
investment in the company. Equity is simply ownership of a corporation. Typically, ownership
units in a corporation are referred to as stock.
However, if our owner did not have necessary funds to start their own business they could finance
their operation in one of two ways:
So, what are the advantages of selling stock?
WHY DO CORPORATIONS ISSUE STOCK?
Businesses issue stock
to raise capital.
Advantages of issuing stock:
1. A Company can raise more capital than it could borrow.
2. A Company does not have to make periodic interest payments to
creditors.
3. A Company does not have to make principal payments.
Disadvantages of Issuing Stock:
ADVANTAGES FOR STOCK HOLDERS
As part owner of a corporation, you may be entitled to share in the profits of the company. There is also a chance that the company will grow and the price of the stock may rise.
If the company achieves economic success, the stock value will go up and stockholders
will benefit. For example, if you invested $1,000 to buy 100 shares of a company at $10 each
and the shares rose to $13 each you would gain $300. This is equivalent to a 30% return.
In cases like this, both the stockholders and the business would be pleased.
This concludes the brief tutorial on why companies issue stocks.
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