Sources of Finance Flashcards
What are the two main sources of finance for a company?
The two main sources of finance are: 1. Equity: Funds raised by issuing shares of the company’s stock. 2. Debt: Funds borrowed from external sources, such as banks or bonds, which need to be repaid with interest.
How does the amount required influence the choice between debt and equity?
The amount required affects the choice because: - Debt: Access to long-term bank lending may be limited by the risk appetite of banks. For large amounts, banks might not be willing to provide the necessary funds. - Equity: If a large amount of capital is needed, raising funds through the sale of equity shares might be necessary, as it doesn’t require immediate repayment but dilutes ownership.
What costs should be considered when choosing between debt and equity?
The costs to consider are: - Ongoing Servicing Costs: Debt: Interest payments are required regardless of company performance. Equity: Dividends may be paid to shareholders, which can be costly but is not obligatory. - Initial Arrangement Costs: Debt: May include loan arrangement fees. Equity: Raising equity might involve higher costs due to underwriting and other fees.
How does the duration of financing impact the decision between debt and equity?
Duration considerations are: - Short-Term Financing (Debt): Typically used for short-term assets or needs. - Long-Term Financing (Debt or Equity): Used for long-term assets. Equity is often used for longer-term investments as it doesn’t have a fixed repayment schedule.
Why might equity be considered more flexible than debt?
Equity is more flexible because: - Companies can choose not to pay dividends in years with low profits or losses. - Debt: Requires regular interest payments regardless of financial performance, reducing financial flexibility.
What should a company consider regarding repayment when choosing debt?
A company should: - Carefully forecast future cash flows to ensure it can meet fixed repayment schedules. - For example, if a company takes out a 10-year loan, it must generate enough cash flow to repay the loan by the due date.
How does financing impact a company’s financial statements?
The impact includes: - Equity Financing: Dilutes ownership but does not affect cash flows directly. - Debt Financing: Increases liabilities and interest expenses, which affects profitability and financial ratios. Stakeholders use financial statements to assess risk based on how the company manages its financing.
What are the two main ways equity shareholders gain a return on their investment?
Equity shareholders gain a return in two ways: 1. Capital Gains: The value of their share increases as the company’s value rises. 2. Dividends: Companies pay cash to shareholders through dividends.
What happens when a company issues new shares?
Issuing new shares dilutes the control of existing owners because new investors gain ownership stakes.
Compare the dividend rate, distribution, and repayment order of ordinary and preference shares.
Dividend Rate: Ordinary Shares: Variable – higher in good years, lower in bad years. Preference Shares: Fixed (e.g., 4% per annum). Dividend Distribution: Ordinary Shares: Paid only after preference dividends. Preference Shares: Paid before ordinary shareholders. Liquidation: Ordinary Shares: Last to be repaid. Preference Shares: Repaid before ordinary shares.
What are the differences in voting rights between ordinary and preference shares?
Ordinary Shares: Typically come with voting rights on major decisions, with each share usually getting one vote. Preference Shares: Typically do not come with voting rights.
What are the five principal methods for raising equity finance?
The five methods are: 1. Initial Public Offer (IPO) 2. Private Placing 3. Introduction 4. Right Issue 5. Bonus Issue
What is an Initial Public Offer (IPO)?
An IPO is the process of offering shares of a company to the public for the first time. Shares are offered at a fixed price, and the process often involves underwriting by an issuing house or banks. It is usually the most expensive method of raising capital and is used by larger companies.
What distinguishes a private placing from an IPO?
Private Placing: Shares are sold directly to institutional investors through a broker, not the general public. It is cheaper and quicker than an IPO but results in a narrower shareholder base.
What does the method of introduction involve?
Introduction involves a company with widely held shares (typically 25% of share capital) becoming publicly tradable on a recognized stock market. It aims to enhance marketability and access to future capital.
What is a right issue?
A right issue allows existing shareholders to buy new shares in proportion to their existing holdings (e.g., 1 for 1), usually at a discounted price.
What is a bonus issue and how does it differ from a right issue?
Bonus Issue: The company issues new shares to existing shareholders by capitalizing reserves. No new capital is raised; it increases the number of shares in circulation and liquidity, but the average value per share decreases. Right Issue: Shares are issued in exchange for consideration that typically increases company assets, such as cash.
What are the types of short-term and long-term debt finance?
Short-term Debt Finance: Overdraft, Short-term bank loan, Certificate of deposit, Treasury bill, Trade credit. Long-term Debt Finance: Bonds, Loan stock, Debentures, Loan notes, Euro bonds, Convertible bonds and warrants, Long-term bank loan.
What is the difference between redeemable and irredeemable debt?
Redeemable Debt: Repayable on maturity. Irredeemable Debt: No repayment required; typically considered perpetual.
