Advantages and Disadvantages of Debentures - Essay Example

Unit 5 Individual Project Introduction Every company, starting from establishment, needs funds. There are many ways of financing the business that a company might use to expand its business operations. Same is the case with the multi billion dollar public MNE, Acme. This paper discusses three of the most useful ways of financing for this company’s proposed overseas production facility. DEBT FINANCING Debt financing is a method of generating funds for investing that consists of borrowing money from a lender with an agreement by both parties i.e. the borrower and the lender that the loan would be paid by a given date in future, usually with interest. Equity financing, on the other hand, is when the investors receive partial ownership in the company when they lend their funds. In that case, the lent amount does not have to be repaid. The interest rates that are charged on the lent funds depend on the degree of risk associated with lending. E.g. if a company is new, does not have a good credit history or ability to make profits, lenders have a greater risk in investing in the company and therefore charge a higher rate of interest on their provided funds. Even though there are several possible methods of debt financing such as private placement of bonds, convertible debentures, industrial development bonds and leverage buyouts, the most common type is a regular loan (financing, n.d.). Loans can be either long-term, short-term, or a credit line. This MNE should be more interested in long term loans with a maturity period of longer than one year as its estimated cost is a massive $500 million. Advantages: Debt financing is relatively less difficult to attain as compared to equity financing. The profits that a company makes on the lent funds do not have to be shared with the lenders as would be the case if the lenders had ownership in the company. Therefore the borrower gets to keep maximum amount of profits. Interest on debt is tax deductible. As interest that has to be paid on the borrowed money is known, realistic forecasts can be made and therefore suitable strategies can be adopted. Disadvantages Sooner or later, the company would have to repay the entire amount of debt, with interest. Just how much loan a business can take is limited by the ability of the business to repay it. The borrower usually pledges assets of the company to the lender as collateral (financing, 2003). The company needs to take both, the principal and the interest payments into account which can cause pressure on the cash outflow and should be taken into consideration in future plans. The business can face a crisis situation if it is unable to pay back the debt. JOINT VENTURE A joint venture is a strategic alliance between two or more parties to take on a particular project. Joint venture is very similar to a partnership whereby two entities have an agreement to use their resources together for a certain project. However a partnership usually involves a long-term business relationship whereas a joint venture is limited to a single business project. The associated parties wish to enter a joint venture to gain individual benefits, which is usually a share of the project objective. The joint venture itself has no legal standing. Therefore the expenses, revenues and asset ownership usually flow through the project to the members (Venture, n.d.). Once the project is completed, the temporary partnership comes to an end. Advantages Assists in providing access to new markets and distribution networks Increases capacity available for the involved parties Makes it possible for risks to be shared. Increases resources available for the parties, including capital, specialized staff and technology Does not include commitments like in partnerships and therefore can be flexible. Disadvantages The objectives might not be totally clear and might not be explicitly communicated to all the associated members. The parties in the venture might be pursuing different objectives that might even end up being contradictory The levels of expertise and resources contributed into the venture by the partners might be imbalanced and therefore might result in an imbalanced involvement into the project It often happens that as the partners have different customs and styles of management, disagreements and conflicts cause co-operation and integration of poor quality. DEBENTURES Debenture is a kind of a debt. The debt however is backed only by the company, not by any collateral. In debentures, even though the borrowing company does not keep assets as guarantee pay back for the lenders but the lenders are still considered creditors in case of bankruptcy. Debentures are ideal for large companies. They can be a great tool for raising funds. Advantages Debentures leave specific assets burden free, therefore leaving them available for use in other financing. Debentures are normally transferrable by the debenture holder thereby attracting more lenders. The interest given to the lenders is a charge against profits. Disadvantages Debentures are usually issued against a relatively higher rate of return As the value of the bond is determined by how successful the company is, it might drive back investors. Conclusion For any business organization to finance its operations, the goal is to secure a loan with the least amount of collateral, the lowest interest rate offered to lenders, and the best repayment terms. Acme would have to take the same points into consideration when financing its $500M project. Keeping the different financing methods and their advantages and disadvantages discussed into consideration, the optimum financing technique, in my opinion, should consist of debt financing with either debenture or a joint venture. The company is worth billions of dollars and is in a position to be able to take a big amount of loan. At the same time, debt financing is relatively easier to obtain. If the company feels alright to join hands with another company, then it would be wise to take up a joint venture with it so there is relatively lesser burden of interest. Otherwise, debentures could be used. Works Cited 1) Debentures?, W. A. (2008, january 2). What Are The Advantages And Disadvantages Of Debentures? Retrieved may 28, 2008, from www.whalehookloans.com: http://whalehookloans.com/2008/01/02/what-are-the-advantages-and-disadvantages-of-debentures/ 2) financing, d. (n.d.). debt financing. Retrieved may 28, 2008, from www.referenceforbusiness.com: http://www.referenceforbusiness.com/small/Co-Di/Debt-Financing.html 3) financing, S. a. (2003, june 30). Should a business consider debt financing? Retrieved may 28, 2008, from www.goliath.ecnext.com: http://goliath.ecnext.com/coms2/gi_0199-2965951/Should-a-business-consider-debt.html 4) Partnering, J. V. (n.d.). Joint Ventures and Partnering. Retrieved may 28, 2008, from www.businesslink.gov.uk: http://www.businesslink.gov.uk/bdotg/action/detail?type=RESOURCES&itemId=1075411648 5) Venture, A. &. (n.d.). Advantages & Disadvantages of a Joint Venture. Retrieved may 28, 2008, from www.rpemery.com: http://www.rpemery.com/articles/advantages_and_disadvantages_jv.htm Read More