Given below are two statements:
Assertion (A): A company in which the current holding of management is on a lower side may prefer debt to a public issue of equity.
Reason (R): Debt is considered to be the cheapest of all the sources of finance.
In the light of the above statements, choose the correct answer from the options given below:
Answer & explanation
Correct answer: option 2
The correct answer is Option (2) → Both (A) and (R) are true but (R) is not the correct explanation of (A).
Assertion (A): A company in which the current holding of management is on a lower side may prefer debt to a public issue of equity. — True. A public issue of equity brings in new shareholders. It may reduce the management’s holding and make the company open to a takeover. Debt does not do this.
Reason (R): Debt is considered to be the cheapest of all the sources of finance. — True. Debt costs less than other sources. The interest on it is tax-deductible, which makes it still cheaper.
Why R does not explain A?
R is about cost, and debt is cheap for every company. A is about a company whose management holds a small share. Its choice turns on keeping control, and R says nothing about control.
The correct reason for A is that debt normally does not dilute control. A public issue of equity may cut the management’s small holding further and make the company vulnerable to takeover.
NCERT (2026-27 Edition): “Financing Decision … The cost of each type of finance has to be estimated. Some sources may be cheaper than others. For example, debt is considered to be the cheapest of all the sources, tax deductibility of interest makes it still cheaper. …” “11. Control: Debt normally does not cause a dilution of control. A public issue of equity may reduce the managements’ holding in the company and make it vulnerable to takeover. This factor also influences the choice between debt and equity especially in companies in which the current holding of management is on a lower side.” |