by In this method, the company repays debenture holders directly from its capital, without setting aside profits in advance. Instead of using retained earnings, the company utilizes its available cash, bank balance, or sale of assets to meet redemption obligations.
Features of Redemption Out of Capital
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No Debenture Redemption Reserve (DRR) is created, meaning profits remain available for dividends or reinvestment.
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The company’s total capital reduces as it directly pays debenture holders from existing funds.
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Liquidity is affected, as the company uses cash or sells assets to finance the redemption.
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This method is usually chosen when the company lacks sufficient profits or reserves for debenture redemption.
Procedure for Redemption Out of Capital:
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Identification of Source of Funds: The company determines whether cash reserves, asset sales, or external borrowings will be used.
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Payment to Debenture Holders: On maturity, the company makes direct payments to debenture holders without creating a DRR.
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Reduction in Capital or Liquidity: The company’s financial position may weaken due to a reduction in cash or assets.
Advantages of Redemption Out of Capital:
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Allows the company to distribute more profits as dividends instead of setting aside funds for DRR.
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Can be useful when a company needs to use profits for expansion rather than debt repayment.
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Simplifies the redemption process as no special reserves are required.
Disadvantages of Redemption Out of Capital:
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Reduces the company’s financial strength by decreasing available cash or assets.
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May lead to liquidity problems if the company does not manage its funds properly.
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Increases the risk of default if sufficient funds are not available at the time of redemption.
Comparison: Redemption Out of Profit vs. Redemption Out of Capital
| Feature | Redemption Out of Profits | Redemption Out of Capital |
|---|---|---|
| Source of Funds | Retained earnings and reserves | Direct capital (cash or asset sale) |
| Debenture Redemption Reserve (DRR) | Created to set aside profits for redemption | Not created |
| Impact on Liquidity | Minimal, as profits are reserved in advance | Significant, as cash is paid directly |
| Effect on Shareholder Dividends | Profits set aside, reducing dividend availability | No impact on profits, allowing for higher dividends |
| Suitability | Preferred when profits are sufficient | Used when profits are inadequate for redemption |
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