The Negative Impacts on the Business: Financing Options - Research Paper Example

?External Financing Introduction A company like Acme that needs to expand its operations has several external financing options. This can be either through debt or equity. There are various options including leasing, shares, bonds, debentures, grants, hire purchase, debt factoring and venture capital, among others. Capital structure refers to the way through which companies are able to finance their assets through hybrid securities, debt or equity. Financing of foreign company branches is influenced by local tax rates and the conditions of the capital market. Therefore financing an overseas project depends on effective tax rates. Several factors such as weighted average cost of capital (WACC) and agency costs should be considered in choosing an external funding source. The weighted average cost of capital is the minimum rate that a company is supposed to earn from the existing asset base in order to satisfy the owners, creditors and other capital providers. Agency costs restrict the leverage of a firm. Taking financial risks leads to higher leverage. This also increases the agency cost of debt and leads to lower debt capacity. Leverage helps to reduce the loss in terms of firm value. Therefore debt becomes advantageous especially in firms that have few opportunities of growth or high percentage of assets in place (Trigeorgis, 1995).This report explores the advantages and disadvantages of some of the major external financing options that Acme can employ. Equity The company can raise funds through issuing shares. They can either be common or preferred shares. Owners of common stock are partial owners of the company. They have the right to share company profits or dividends and vote at the company’s general meetings. Dividends paid to shareholders vary depending on the profits that the company is making. They also have preemptive rights to maintain the ownership of the company when gives another stock offering. However, common stock shareholders are the last to receive dividends after all the preferred stock shareholders. Owners of preferred stock also own the company partially but do not have any voting rights. Preferred stock pays fixed dividends. Preferred stock shareholders are the first to receive dividends and incase the company goes bankrupt, they will be paid before the common stock shareholders. Stock shares are advantageous because they are a permanent source of funding for the company and share capital cannot be redeemed. The disadvantage of this external financing method is that the ownership of the company is shared with the shareholders and they might make decisions that might negatively affect the progress of the company (Davidson, 2002). Hire purchase Acme can also get external funding through hire purchase. The organization can acquire assets without investing the full amount in buying them. This agreement allows the company to use an asset for a certain period of time before it can fully purchase them. The firm is able to acquire an asset quickly without paying the full price and after the specified period of time, the company can either return it or purchase it a reduced price. This method is advantageous since the company can pay for the equipment through manageable installments from funds generated by the equipment. The disadvantage is that the total amount of installments exceeds the original cost of the equipment (Giovanelli, 1998). Bonds The company can also get external funding through issuing of bonds. The company offers loans in the form of debt securities. This method does not require companies to give up partial ownership of the company. Bonds have either fixed interest rates or floating rates. More leveraged companies obtain more funding through bonds relative to stocks. This external funding method has several advantages. Issuing bonds is a cheaper method than bank overdrafts or equities since the interest from the debt is tax-deductable while equity dividends are paid out of taxed company’s profits. This strategy also helps companies to monitor their financial stability. Moreover, issuing bonds is advantageous because the creditors do not have voting rights as is the case with stockholders. This option is disadvantageous because highly leveraged companies might experience difficulties in cash flow because no matter the income, they have to meet the coupon payments. Risk increases as the debt-to-equity ratio increases (Graham, Smart and Megginson, 2009). Debentures Acme can get external funds through debentures. These are types of loans that are secured and have floating or fixed charges. The holder of the debenture has a legal interest in the asset and it is impossible for the company to dispose of it without the agreement of the holder. The holders of debentures possess the right to get interest before dividends are payable to shareholders, and regardless of whether the company is making losses or profit. In case of business failure the debenture holders are entitled to repayment of their money before the shareholders. The option is advantageous because it provides an instant and large injection of funding to the company. Moreover, it does not involve giving up any rights of ownership of the company. External funding through debentures is disadvantageous because they are paid at an interest (Giovanelli, 1998). Leasing Acme can acquire the equipment through leasing. Leasing involves a contract between the leasing company and the lessee. The leasing company purchases and retains ownership of the asset that the customer needs. The customer then hires that asset and pays for the period of time of use of the asset. This option has several advantages. In the short run, leasing is cheaper than buying the equipment. Moreover, the equipment can be updated regularly or replaced if it wears out or if the technology changes. In addition, because of regular payments, the management of cash flow is easier. Leasing is disadvantageous because in the long run it is more expensive than purchasing the equipment because the total cost of rental fees is higher than the original cost of the equipment (Graham, Smart and Megginson, 2009). Loans Acme can acquire funds through borrowing loans from lending institutions. Loans are payable within a specified period of time at a certain interest. The main advantage of loans is that the organization will be able to get a large amount of money so as to invest in the acquisition of the equipment without delay. However, loans are disadvantageous because they are repaid at an interest. Therefore the borrower pays the principal together with additional expenses in terms of interest (Audretsch and Lehmann, 2002). Debt factoring Acme can also raise the funds through debt factoring. Debt factoring involves the sale of outstanding customer accounts by a business to a debt factoring company. The factoring company pays a reasonable amount of the value of debts to the business, for instance 80 or 90%. This company then collects the full amount of the business’ debts and pays the remaining amount with a reduction of a charge. This option has some advantages. It enables a business to raise money quickly without having to chase after the debtors. In addition, a business can use the factoring company’s credit control system to evaluate the creditworthiness of existing customers and new ones. Moreover, it minimizes the risk and cost of doing business abroad. Debt factoring has some disadvantages. The company does not receive the full amount of the value of the debts since the factoring company deducts a certain charge. In addition, factoring companies may impose certain constraints on the business which might lead to delays and affect the business operations. Moreover, the factoring company is in charge of maintaining the sales ledger and this might not please customers who prefer dealing directly with the company. Recommendations Several external funding options are viable for Acme Corporation. Debt can be better than equity in terms of tax benefits. When companies borrow money, they deduct interest expenses from the income and end up with a taxable income and this reduces the taxes. Companies using equity cannot deduct equity payments to have a taxable income. Being a large multinational corporation, it is very easy to acquire loans from lending institutions in order to acquire the equipment. The company can also use debt factoring and enjoy the benefits of getting instant funding without going after the debtors. The company could also acquire the equipment through hire purchase and pay for it through installments. Acme can also acquire the equipment through leasing and enjoy the benefits of the equipment being upgraded and repaired regularly by the leasing company in case it wears out or if the technology changes. Conclusion It is evident that there are various options of external funding that are available for organizations. Therefore, choosing a source of external funding requires careful evaluation of all the available options as well as the nature of the organization. Not all options are suitable for every organization and some may have negative impacts on the business. Therefore, Acme Corporation should adopt one or a combination of the options recommended above. Reference List Audretsch, D.B. and Lehmann, E. (2002). Debt Or Equity?: The Role Of Venture Capital In Financing The New Economy In Germany. Germany: Centre for Economic Policy Research Davidson, P. (2002). Financial Markets, Money And The Real World. USA: Edward Elgar Publishing. Giovanelli, P.(1998). External Funding Opportunities: A Report On External Funding Opportunities For Commonwealth Cultural Institutions. Australia: The Project. Graham, J., Smart, S.B. and megginson, W.L. (2009). Corporate Finance: Linking Theory To What Companies Do. Great Britain: Cengage Learning. Trigeorgis, L. (1995). Real Options in Capital Investment: Models, Strategies, and Applications. USA: Greenwood Publishing Group. Read More