First, consider some basic background information concerning the differences between not-for-profit organizations and investor-owned firms. What problem do not-for-profit businesses encounter when they attempt to implement the trade-off theory?

Question

Sandra McCloud, a finance major in her last term of college, is currently scheduling her placement interviews through the university's career resource center. Her list of companies is typical of most finance majors: several commercial banks, a few industrial firms, and one brokerage house. However, she noticed that a representative of a not-for-profit hospital is scheduling interviews next week, and the position--that of financial analyst--appears to be exactly what Sandra has in mind. Sandra wants to sign up for an interview, but she is concerned that she knows nothing about not-for-profit organizations and how they differ from the investor-owned firms that she has learned about in her finance classes. In spite of her worries, Sandra scheduled an appointment with the hospital representative, and she now wants to learn more about not-for-profit businesses before the interview.
To begin the learning process, Sandra drew up the following set of questions. See if you can help her answer them.

Answer 1

The major problem encountered by not-for-profit firms in implementing the trade-off theory is their lack of flexibility in raising equity capital. Not-for-profit firms do not have access to the typical equity markets. Thus, it's harder for them to raise fund capital, via government grants and private contributions, than it is for investor-owned firms to issue new common stock. As a consequence, it is often necessary for not-for-profit firms to delay worthy projects because of insufficient funding, or to use more than the theoretically optimal amount of debt.