INTRODUCTION Companies need to choose from among various sources of finance depending on the amount of capital required and the term for which it is needed. Finance sources can be divided into three categories, namely traditional sources, ownership capital and non-ownership capital. Traditional sources are the internally generated capital (retained earnings); ownership capital is the capital owned by shareholders of the company (ordinary shares) while non-ownership capital includes funds from lenders such as banks and creditors.
In view of this report, it is exclusively focused on xternal financing which is ownership and non-ownership capital. Long term sources of finance are those that are needed over a longer period of time, usually over a year. The reasons for needing long term finance are generally different to those relating to short term. The major reason for sourcing for long term finance for companies is to be able to carry out its capital intensive projects which in the long run cannot or may not be adequately funded by its retained profits.
Most important aspects of any investment from the perspective of both the investor and company are to be able to minimize risk and maximize profit. Investment bankers and corporate finance specialists assist firms in identifying financial needs, evaluating capital structure models and finding interested investors. Analysis of Key Differences between Gravier Plc And Expo Plc Gravier plc is a public limited liability with an annual turnover of E200million and requires new finance in the total sum of E50million in order to be able to produce using a new plant, materials for road building.
Thus, for it to be able to produce these materials, new plants and machinery will be required. On the other hand, Expo plc has an annual urnover of E5million and has a public service customer and requires a new finance worth E8million to relocate from its existing research laboratory to a new location with a stronger market for its product. As public limited companies, they already have equity capital (although not clearly stated in what proportion). In this report, as the financial consultant, I am assuming that the total assets and leverage conditions recommendations.
Both companies need long term finance for expansion into a new sector for Gravier Plc and for Expo plc, a new market. SUGGESTIONS FOR SOURCE OF FINANCE Gravier plc For Gravier plc, I will recommend Project Financing. This is because of the type project the company is trying to invest in. Investopedia defines project financing “as a form of long term financing of infrastructure and industrial projects based upon the projected cash flows of the project rather than the balanced sheets of its sponsors. In other words, a special purpose entity is created for the project, thereby shielding other assets owned by a project sponsor from detrimental effects of a project failure. It is also a non-recourse loan (a secured loan that is secured by a ledge of collateral, typically real property but for the borrower, he is not personally liable). It usually involves a number of equity investors, known as sponsors as well as a syndicate of banks or other lending institutions that provide loans to the operation.
The loan is usually secured by the project assets and paid entirely from the projects cash flow rather than from the general asset or credit worthiness of the project sponsors. In comparison to other forms of ordinary loans, the bank examines the credit standing of the borrower when deciding terms and conditions. The main focus s on the financial prospects of the project itself. However, Gravier plc needs to make use of project financing in a way that the project is identifiable and separable from the rest of its operational activities so that its cash flows and assets can offer the lenders some separate security.
According to Glen Arnold (2013), the following are the advantages of project financing to the company: a) Transfer of risk: The project is a “stand -alone” investment with its own financing where if successful, the company gains and if otherwise, it does not affect other cash flows and assets of the company ) Off balance -sheet financing: The finance is raised on the project’s assets and cash flows and therefore is not recorded as debt in the company’s balance sheet. ) Simplifies the banking relationship: In cases where there are a number of parent companies, it can be easier to arrange finance for a separate project entity than to have to deal with each of the parent companies separately. From the perspective of the lenders (investors), the following are the advantages of project financing: a) the company. b) Strict dividend policy and reinvestment decisions as there are an immediate pay out. No reinvestment allowed. c) It is a highly transparent form of investment as the lenders are usually well informed.
Disadvantages a) To the company, there is a relatively high cost and risk involved due to documentation and longer gestation period. b) The capital investment decisions are completely transparent to creditors. c) To investors, there is a big question: what if the project is not profitable, what happens to our capital? This means there is a high risk of recouping all of the initial capital invested Expo plc Expo plc is a biotechnological company desiring to acquire a larger market. I will recommend it issues more shares.
In addition to its existing shares, expo plc can raise new equity capital by issuing rights issue to its shareholders and script issues to attract new investors. Because it is trying to attract a new market, there is a high possibility that not much profit may be made for the first year. Thus, the dividend payments can be suspended, re-invested to support the new capital raised. The existing research laboratory can also be leased out once the expected finance is raised. Ordinary shares represent the equity capital of a firm. It is a form of finance hat remains when all other forms of finance (bonds and preference shares) “come and go’.
It is a method that is adopted when a company needs to raise large amount of capital. This may not be achieved with the issuance of bonds as whether profit is made or not during the financial year, the company has to pay the interest on capital borrowed. It is also known as the risk capital of the business. For Expo plc, equity capital long term form of finance has the following advantages to the company: a) There is no obligation to pay dividends. As earlier mentioned, when losses are made, he company is not obliged to source for funds to pay dividends.
Equity acts like a shock absorber. b) The capital does not have to be repaid. There is no redemption date for shares thus capital remains in the business but holders of shares may change from time to time. c) There is no interest payment. d) A company that is highly financed by equity is recognized as being financially healthy and stable (as well as less risky). All equity shareholders expect a certain return on their investments. Companies based on the textbook world are obliged with the sole responsibility of maximizing shareholders wealth.
The investors in this form of capital have the following advantages: a) The shareholders have voting rights and are recognized as the owners of the company. b) There is no limit to capital gains especially in the year of financial boom. c) They have voting rights and thus can have significant effect in the decision making of the firm in relation to control. Disadvantages of Equity Capital a) High risk: to companies, acquiring and maintaining equity capital can be expensive in terms of return on capital and other transactional costs like issue and legal costs. b) Loss of control.
Managers may be faced with either issuing shares to external investors or retaining control. c) The dividends are not tax deductible. d) To shareholders, they are usually the last on the queue to be paid dividends (if there is any extra profit after tax and interests have been deducted). The same situation is eminent in the event of liquidation. Every business must maintain a reasonable proportion between the amounts of debt that it has compared to the amount of equity. The purpose of this report is to recommend a long term source of finance for Expo plc and Gravier plc.
Suggestions nd recommendations made are based on the available information. Based on this, equity capital long term finance is suggested for Expo plc and Project financing long term source of finance for Gravier Plc. Advantages and disadvantages of each source of finance have been reviewed thoroughly and it is recommended that both companies based on their financial strength weigh their options. REFERENCES Arnold, Glen (2013). Corporate Financial Management (5th Edition) Harlow, England: Pearson. Wishwoode, B. (2012). Project Financing. Available: http:// www. investopedia. com/articles/. Last accessed 9th November, 2013.