11. Sources of long-term finance Flashcards
What are the advantages of issuing equity shares from a company perspective?
How can companies raise finance from a rights issue?
The advantages of issuing equity shares are as follows.
Equity shares are permanent capital and a long-term source of finance.
Normally, the capital raised is not required to be paid back during the lifetime of the company, other than in the event of liquidation.
The dividend on equity shares is not a liability for the company. To protect the interests of creditors, a company may declare a dividend only if it has sufficient profit available for the purpose.
A company that raises capital with equity shares gives a positive outlook of the company, providing greater confidence to investors and creditors.
How can companies raise finance from rights issue?
Companies can raise finance by making a rights issue that offers existing shareholders the right to buy new shares in proportion to their existing shareholdings. Rights issues enables shareholders to retain their existing share of
voting rights.
What factors should you consider when choosing between sources of finance?
The main factors to consider when choosing between sources of finance are summarised below.
- Access to finance: the ability of a company to raise equity finance is dependent on its access to the investors. Quoted companies can issue both
new shares and make rights issues. However, unquoted companies can
only raise finance by rights issues and private placings due to its restricted
access to public. There are also statutory restrictions: in the UK, only public
limited companies may offer shares to the general public. - Control: Raising funds through internally-generated funds and
rights issues results in no change to shareholder control. However, if
diversification of control is desired, then an issue to the public will be
preferred. - Amount of finance: the amount of finance that can be raised by a rights
issue is limited and dependent on the amounts that can be raised from
the existing shareholders. There is more flexibly for quoted companies for
the amounts that can raised from the general public that opens up the full
financial resources of the market. - Cost of raising finance: flotations incur significant costs in management
and administrative time and may not be a viable option for smaller
companies. Use of internally generated funds is the cheapest and simplest
method. For shares, public offers are the most expensive, following by
placings and then by rights issues. - Pricing the issue: setting the price correctly is the most difficult area for
all shares. For public issues, there is a danger of undersubscription if it is
set too high, unlike a placing which is pre-agreed and negotiated to be
attractive enough to the subscribing institutions. A rights issue bypasses
the price problem since the shares are offered to existing shareholders. For
unquoted companies, pricing is more complex as they cannot refer to no
existing market prices.
Why would investors be interested in preference shares with warrants attached?
Warrants attached to a preference share are attractive to investors because they offering the potential to earn a profit in the future. Warrants are rights given to lenders allowing them to buy new shares in a company at a future date at a fixed price (the exercise price). If the current share price is higher than the exercise price, then the warrant holder has a potential to make a profit by getting the shares at a cheaper exercise price in the future.
How can purchasing assets via leases assist in managing a company’s cash levels?
The biggest advantage of leasing is that cash outflow or payments related to leasing are spread out over several years, hence saving the burden of one-time significant cash payment to purchase an asset outright. This helps a business to maintain a steady cash-flow profile.
What are the limitations of PFI?
What are the limitations of PFI?
PFI schemes are controversial due to the wasteful spending built into the public sector procurement agreements that are part of PFI projects. There are many stories of flawed projects. The biggest disadvantage is the high annual cost charged to the public sector for the project. The costs have been significantly larger than the annual cost of comparable projects. Many of the projects have run over budget. For example, the cost of private sector finance in the 2000s increased the overall debt cost of the UK government, indirectly costing taxpayers.
Since the asset ownership is transferred to the private sector it may lead to a loss of control and accountability by the public sector. The ultimate risk of inflexibility and poor value for money with a project lies with the public sector. Repair or maintenance costs could also be higher. The administration cost spending on advisers and lawyers and the costs of the bidding process could cost millions.
What is the difference between budgeting and forecasting?
Budget: A budget is a financial plan directing and allocating the financial resources of a business usually for one year.
Budget: A budget is a financial plan directing and allocating the financial resources of a business usually for one year.
Forecasting: Financial forecasting is a projection of a company’s future financial outcomes over a long period of time. What is the difference between a budget and a forecast? – A budget is a plan what the company wants to achieve. A forecast is the prediction of what will actually be achieved.
What is budgetary control?
What is the difference between a budget and a forecast? – A budget is a plan what the company wants to achieve. A forecast is the prediction of what will actually be achieved.
Variance is the difference between the budget and the actual result]
Chapter 11 summary
Chapter summary
Finance is important for companies who require capital to finance longterm
investments and overall working capital. A company can look at
various sources to fulfil these long-term financial requirements. The choice
is generally between equity finance (from shareholders) and debt finance
(from lenders).
Equity finance refers to the finance relating to the owners or equity
shareholders of the company. Equity finance is represented by the issued
equity share capital (raised through new issues, including rights issues) plus
other components of equity such as retained earnings.
Debt is the main alternative to equity. It involves the payment of interest. It
can be used for both short-term and long-term purposes and may or may
not be secured.
Preference shares take the following forms:
– Cumulative and non-cumulative
– Redeemable and irredeemable
– Participating and non-participating
– Convertible and non-convertible
Bonds and debentures (bonds and loan stocks) take the following forms:
– Bonds with fixed interest (coupon payment)
– Deep discount and zero-coupon bonds
– Eurobonds
– Share warrants (options)
A leasing agreement is formed between two parties: a lessor (who owns
the asset but does not have use of it) and a lessee (who does not own the
asset but does have the use of it). The lessor is considered to be the legal
owner and can claim capital allowances for the asset. The lessee makes
payments to the lessor for the use of the asset.
The biggest advantage of leasing is that cash outflow or payments related
to leasing are spread out over several years, hence saving the burden of
one-time significant cash payment to purchase an asset outright. This helps
a business to maintain a steady cash flow profile.
A sale and leaseback arrangement is a structured transaction in which an
owner sells an asset to another party (the buyer-lessor), while maintaining
the legal rights to use the asset or lease back from the buyer-lessor.
Other forms of long-term finance include:
– bank and institutional loans
– securitisation of assets via the use of special purpose vehicles
– private finance initiatives
– government assistance
