A company that builds a power plant, a factory or a chain of shops needs money for many years, not months. Where can it find it? From its owners, by keeping profit or selling shares; from lenders, by taking a term loan or issuing bonds; from a mixture, such as preference shares and convertibles; or from a lessor, which owns the asset and lets the company use it.
Each source has a different cost, a different claim on the company’s cash and assets, a different effect on control and a different attitude to risk.
This topic gives an overview of the long-term sources of finance and then concentrates on long-term debt: its features, why a company would finance a project with a bond, and how a bond compares with a bank loan, with a worked calculation of the true cost of each. It also explains preference shares, leases and sale and leaseback, and the factors in choosing between debt and equity. The next topic covers the issue of new shares.
The comparison of bonds and bank loans, and the reasons for financing a project with a bond, were tested in May Diet, 2026, Question 2(c) (4 marks) and Question 6(a)(i) (5 marks). Read short-term sources of finance first.
In 30 seconds
Long-term finance comes from equity (retained profit and new shares), debt (term loans and bonds), preference shares and convertibles (hybrids), leases (including sale and leaseback) and, for smaller or newer firms, venture capital. Debt is cheaper than equity because lenders face less risk and interest is tax-deductible, but it must be paid and increases financial risk.
A bond raises larger sums for longer, often at a fixed rate and with fewer restrictions than a bank loan, from many investors, but needs a credit rating, regulatory approval, disclosure and issue costs. A bank loan is quicker and cheaper to arrange and easier to renegotiate, but is usually shorter, floating-rate and secured, with covenants. Match long-term assets with long-term finance, and compare the after-tax cost including issue costs.
The main long-term sources
- Equity: finance from the owners. The main source for most companies is retained profit: it has no issue costs and needs no new investors or approval, but is limited by profitability, by the need to earn a return on it and by the expectations about dividends. New shares can be issued for cash or in exchange for the shares of a company being acquired (the next topics).
- Debt: term loans from banks and development finance institutions, and bonds sold to investors.
- Preference shares and convertibles: instruments between debt and equity.
- Leases: a finance lease or a sale and leaseback gives use of assets without a large cash outlay (covered earlier in this course).
- Venture capital: equity finance from specialist investors for small and growing businesses (covered in the topics on small and medium-sized enterprises).
- Efficiency in working capital: reducing inventory and receivables releases cash that can be used for investment, a one-off source.
Long-term debt
Debt is borrowed money to be repaid with interest. Its main features are:
- Interest: fixed, or floating (linked to a market rate such as the Monetary Policy Rate, which the Central Bank of Nigeria set at 23% on 22 September 2026); a bond may also be issued at a discount with no interest (a zero-coupon bond).
- Redemption: repayable on a set date (redeemable), in instalments, or never (irredeemable).
- Security: a secured loan or bond gives the lender a charge over specific assets (a fixed charge) or all assets (a floating charge); an unsecured one relies on the borrower’s credit and so costs more.
- Covenants: conditions that the borrower must keep, such as a maximum ratio of debt to equity or a minimum interest cover; a breach may allow the lender to demand repayment.
- Tax: interest is deductible in computing taxable profit, which lowers the real cost of debt; dividends on shares are not deductible.
- Priority: debt holders rank ahead of shareholders if the company is wound up and have a legal right to interest, so debt is less risky for the investor and cheaper for the company than equity.
A term loan is a loan from a bank (or development finance institution) for a fixed period with a repayment schedule. A bond is a debt security sold to many investors, with a trustee acting for them.
In Nigeria a public corporate bond needs a credit rating of investment grade from a recognised rating agency, approval of the Securities and Exchange Commission under the Investments and Securities Act 2025, and is then listed or quoted on an exchange such as the FMDQ Securities Exchange or the Nigerian Exchange.
Outstanding corporate bonds on the FMDQ Securities Exchange reached ₦2.30 trillion in June 2026, and coupons in 2026 ranged from about 12.5% on older issues of the strongest names to 20% on a first issue by a smaller issuer: the better the credit rating and track record, the lower the cost.
Why finance a project with a bond
- Matching: a long-term project needs long-term finance, so the repayment is spread over the life of the project’s cash flows instead of being due in a year or two.
- Cost: the coupon is generally lower than the cost of equity, and, after tax relief on the interest, lower still; if the rate is fixed the company knows its cost for years.
- No dilution: existing shareholders keep their control and their share of the profit above the interest.
- Size and tenor: a bond can raise sums larger than one bank wishes to lend, for periods of seven years or more.
- Wider investor base: pension funds and insurers that cannot lend like a bank may buy the bond.
- Gearing effect: if the project earns more than the after-tax cost of the debt, the surplus goes to the shareholders and raises their return (financial leverage).
Bonds or bank loans?
| Bond | Bank loan | |
|---|---|---|
| Amount | Large, from many investors | Limited by the bank’s lending limit |
| Term | Long, often 5 to 10 years or more | Usually shorter |
| Rate | Often fixed; priced on the issuer’s rating | Often floating, repriced |
| Covenants and security | Fewer; may be unsecured for a strong issuer | More; often secured |
| Speed and cost of arranging | Slow and costly: rating, trustee, issuing house, legal and listing costs | Fast and cheap |
| Disclosure | Full disclosure and continuing obligations | Private |
| Flexibility | Hard to change terms or repay early | Easier to renegotiate or prepay |
| Public profile | Raises the profile and builds a market presence | None |
A bond therefore suits a large, strong company that needs a large sum for a long period and can bear the fixed costs of issue; a bank loan suits a smaller amount, a shorter term or a company that cannot meet the rating and disclosure requirements.
The true cost: a worked comparison
A company needs ₦5.0bn for seven years. Option 1: a bond with a coupon of 19%, issue costs of 2% (₦0.1bn) and annual trustee and rating costs of ₦0.02bn, redeemed at ₦5.0bn. Option 2: a bank loan at a floating rate assumed at 27%, with a 1% arrangement fee. Tax is 30%.
Annual interest: bond 5.0 × 19% = ₦0.95bn; loan 5.0 × 27% = ₦1.35bn, so the bond saves ₦0.40bn a year before tax. After tax relief the bond’s interest costs 0.95 × 0.70 = ₦0.665bn. The net proceeds of the bond are 5.0 − 0.1 = ₦4.9bn (the loan: ₦4.95bn after its fee).
The rate that equates the net proceeds to the after-tax payments and the redemption (a calculation like the cost of redeemable debt) is about 14.0% after tax for the bond (20.0% before tax) and about 19.2% after tax for the loan (27.3% before tax). The bond is much the cheaper source, but the loan can be arranged within weeks and does not need a rating.
Preference shares and convertibles
Preference shares carry a fixed dividend that must be paid before any ordinary dividend. They may be cumulative (unpaid dividends accumulate), redeemable, participating or convertible, and usually have no vote. Dividends are not tax-deductible, so the cost is the dividend divided by the issue price with no tax adjustment: a 12% preference share at par costs 12%, compared with 14% × 0.70 = 9.8% for debt costing 14% before tax.
Preference shares are less common in listed companies. A convertible bond pays a lower coupon because the holder may exchange it for ordinary shares at a stated ratio, sharing in the growth of the company; the valuation is covered later.
Leases, sale and leaseback
A finance lease gives use of an asset for most of its life in return for rentals, so the company avoids a large outlay and the risk of obsolescence may pass to the lessor. In a sale and leaseback the company sells an asset it owns, such as a building, to a financier and leases it back, releasing cash while keeping the use of the asset.
Under International Financial Reporting Standard (IFRS) 16 these leases appear on the statement of financial position of the lessee as liabilities, so they add to gearing.
Debt or equity?
- Cost: debt is cheaper (lower risk to the lender, tax relief on interest).
- Risk: debt adds fixed payments and the risk of default, so increases financial risk and gearing; equity has no fixed obligation.
- Control: new shares dilute control; debt does not (but covenants restrict management).
- Flexibility and availability: a company with unstable profits or few assets to offer as security may find debt unavailable.
- Tax: interest is deductible; dividends are not.
- Matching and the existing structure: the right mix depends on the assets, the stability of the cash flows and the gearing already carried, covered in the topics on capital structure.
The ideas in more depth
Why debt is cheaper than equity
Lenders have a contractual claim to interest and repayment, a security over assets and priority in liquidation. Shareholders get what is left. Because they carry more risk they demand a higher return. The tax relief on interest cuts the cost of debt still further.
But the saving is not free: as debt rises, the risk to shareholders rises and so does the return they require, which is the subject of the later topics on gearing.
Why issue costs matter
A bond issue has a large fixed cost (rating, trustee, issuing house, lawyers, registration), which is spread over the amount raised and the years of the bond. For a small issue it can make the true cost much higher than the coupon. For a large issue it is small. This is one reason that only larger companies use the bond market.
Sources and references
- The Investments and Securities Act 2025 and the rules of the Securities and Exchange Commission for bond issues; the rules of the FMDQ Securities Exchange and the Nigerian Exchange for listing; International Financial Reporting Standard (IFRS) 16 Leases.
These points are stated as at 5 November 2026.
Worked examples
Example 1: the interest saving. ₦5.0bn at 19% (bond) or 27% (loan). Required: the annual interest saving before tax.
- Interest. 0.95 against 1.35.
- Saving.
1.35 − 0.95 = ₦0.40bn.
Example 2: net proceeds. Bond of ₦5.0bn with issue costs of 2%. Required: the net proceeds.
- Costs.
2% × 5.0 = ₦0.1bn. - Net.
5.0 − 0.1 = ₦4.9bn.
Example 3: the after-tax cost of debt. Debt costing 14% before tax; tax 30%. Required: the after-tax cost.
- After tax.
14% × 0.70 = 9.8%.
How to answer in the exam
- Tie each point to the case: the size, life and risk of the project and the company’s position.
- Give benefits and drawbacks of each source, and a reasoned recommendation.
- Quote after-tax costs and include issue costs when comparing.
- Note gearing and covenants as risks of more debt.
Common mistakes in the exam
- Listing features without applying them to the scenario.
- Forgetting the tax relief on interest.
- Comparing a coupon with a floating loan rate without the issue costs.
- Saying that debt is always better because it is cheaper.
- Ignoring the effect on gearing and risk.
- Confusing preference shares with debt for tax purposes.
Quick revision
- Sources: equity, debt, hybrids, leases, venture capital.
- Debt is cheaper (lower risk, tax relief) but adds fixed payments and gearing.
- Bond: big, long, fewer covenants, but rating, disclosure and issue costs.
- Bank loan: quick and flexible, but shorter, floating, secured.
Practice questions
These are original questions written in the style of the Institute’s exams. Try each one before you open the answer. Section A is a recall check, because the paper itself is written.
Recall check: multiple choice
Question 1. The main source of new equity for most companies is:
- Bank loans
- Bonds
- Retained profit
- Leases
Show the answer
C. It has no issue costs.
Question 2. Debt is cheaper than equity partly because:
- Lenders take more risk
- Interest is tax-deductible and lenders are paid first
- Debt is never repaid
- There are no fees
Show the answer
B. Lower risk and tax relief.
Question 3. A secured loan gives the lender:
- A charge over assets
- A vote
- A share of profit
- No rights
Show the answer
A. So the lender can enforce it on default.
Question 4. A covenant is:
- A dividend
- A tax
- A share
- A condition the borrower must keep, such as a limit on gearing
Show the answer
D. A breach may allow the lender to demand repayment.
Question 5. A public corporate bond in Nigeria needs:
- No rating
- An investment-grade credit rating
- A bank guarantee only
- No approval
Show the answer
B. Together with regulatory approval and a trustee.
Question 6. A reason to finance a long-term project with a bond is:
- Matching the term of the finance to the life of the project
- Quick approval
- No disclosure
- No issue costs
Show the answer
A. Repayment is spread over the project’s life.
Question 7. A disadvantage of a bond compared with a bank loan is:
- Shorter term
- Floating rate
- High issue costs, rating and disclosure requirements
- Strict covenants always
Show the answer
C. It is slower and costlier to arrange.
Question 8. Preference share dividends are:
- Tax-deductible
- Always cumulative
- A legal obligation like interest
- Not tax-deductible
Show the answer
D. So the cost has no tax adjustment.
Question 9. In a sale and leaseback the company:
- Buys a new asset
- Sells an asset and leases it back
- Issues shares
- Repays a bond
Show the answer
B. It releases cash but keeps the use of the asset.
Question 10. More debt in the capital structure increases:
- Financial risk and gearing
- Dividends
- Equity
- Retained profit
Show the answer
A. Because interest is a fixed obligation.
Section B style: written questions
Question 11 (10 marks). (a) State FOUR reasons for financing a long-term project with a bond. (4 marks) (b) State THREE drawbacks of a bond compared with a bank loan. (3 marks) (c) State why debt is cheaper than equity. (3 marks)
Question 12 (15 marks). A company issues a ₦3.0bn five-year bond with an 18% coupon, redeemable at par, with issue costs of 2%. Tax is 30%. (a) Calculate the net proceeds and the annual interest. (4 marks) (b) Calculate the annual interest after tax relief. (3 marks) (c) State the approximate after-tax cost, given that the rate equating the net proceeds with the after-tax payments is 13.2%. (3 marks) (d) State why this is below the coupon. (5 marks)
A further written question
Question 13 (20 marks). A company needs ₦8.0bn. A term loan at 26% is offered; a bond with an 18% coupon and issue costs of 2.5% (₦0.2bn) is also possible. Tax is 30%.
(a) Calculate the annual interest on each. (4 marks) (b) Calculate the annual interest after tax relief on each. (4 marks) (c) Calculate the annual after-tax saving from the bond and how long it takes to cover the issue costs. (5 marks) (d) State THREE non-financial factors in the choice. (4 marks) (e) State the cost of a 12% preference share at par and compare it with debt costing 14% before tax. (3 marks)
Model answers
Show the model answer to Question 11
(a) Matches long-term finance to the long-term project; fixed, lower cost with tax relief; no dilution of control; large sums for long periods; wider investor base (1 each, any four).
(b) High issue costs; rating and regulatory approval needed; full disclosure; hard to renegotiate or repay early (1 each, any three).
(c) Lenders have a contractual claim and priority, so they take less risk and accept a lower return (2); interest is tax-deductible (1).
Show the model answer to Question 12
(a) Issue costs 2% × 3.0 = ₦0.06bn; net proceeds ₦2.94bn (2); interest 18% × 3.0 = ₦0.54bn (2).
(b) 0.54 × 0.70 = ₦0.378bn (3).
(c) About 13.2% (3).
(d) Interest is tax-deductible, which reduces the cost by the tax rate (3); the issue costs raise the cost a little above 18% × 0.70 = 12.6% (2).
Show the model answer to Question 13
(a)
- Loan 8.0 × 26% = ₦2.08bn
- bond 8.0 × 18% = ₦1.44bn (4).
(b)
- Loan 2.08 × 0.70 = ₦1.456bn
- bond 1.44 × 0.70 = ₦1.008bn (4).
(c)
- Saving 1.456 − 1.008 = ₦0.448bn a year (3)
- issue costs of ₦0.2bn are covered in 0.2 ÷ 0.448 = about 0.45 years (2).
(d) Speed of arrangement; rating and disclosure; covenants and security; flexibility to prepay; public profile; the investor base (1 mark each, any three; one further mark for application to the case).
(e) The preference share costs 12% because there is no tax relief; debt at 14% before tax costs 14% × 0.70 = 9.8% after tax, so debt is cheaper (3).
Pathfinder on Long-term sources of finance: equity, debt, hybrids and leases
These are the ICAN Pathfinder questions that test this topic. ICAN owns the questions and the suggested solutions, so we point you to them and do not copy them. Open your Pathfinder, attempt each question under exam conditions, then check your answer against the notes above.
Part (a)(i) asks why a company might finance a project with a bond (5 marks).
Revise first: Why finance a project with a bond
Part (c) asks for the benefits of issuing bonds compared with taking bank loans (4 marks).
Revise first: Bonds or bank loans?
Source: ICAN Pathfinder, Financial Management. Diets covered: Every diet in the Pathfinder, November Diet, 2025 and May Diet, 2026, was reviewed here. The diets listed above test this topic directly..
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