Sources of Capital in Duke Plc - Assignment Example

Sources of Capital in Duke Plc. Introduction Duke Plc. has been successfully running its business operations all over the world. This study is about all the sources of capital available to the company to finance its long term projects. Different debt and equity sources of capital and its merits and limitations have been included in this study. The utilization of gearing while formulating such effective capital structure has also been studied. Furthermore, the dividend policy of the company that has a relevance to the expectations of the investors of the company has been discussed in this study. The knowledge of all these financial management issues related to the company can prove to be advantageous for the development of successful strategies by the Board members of the company. Sources of Capital Finance is considered to be the life blood of any business organization. For large multi-national organizations like Duke Plc., there is a huge requirement of capital to finance its long term projects. Long term finance Duke Plc. might require funds so as to facilitate purchase of plant, machinery, furniture, land, building, etc. and other types of fixed assets. In addition to this, a portion of working capital can also be considered to be of fixed or permanent nature. Hence, funds required by Duke to finance all these avenues are termed as long term finance (Nos.org, n.d. p.29-31). Sources Various sources of long term financing of a company can be broadly classified into debt funds and equity funds. All the different types of capital employed by the company constitute the capital structure of the company. Companies like Duke have the option of raising funds from different sources of debt funds for its long term financing needs like, loans, debentures, etc. Equity as a source of long term financing includes, equity shares, preference shares, retained earnings, etc. Equity Financing Equity financing as a source of capital for Duke Plc. for financing its long term projects includes equity shares, and preference shares. Equity Shares: Issuance of shares to the general public by companies like Duke is the main source of long term financing for the company. The shares of the company issued to the public helps to generate funds which could be utilized for financing long term projects of the company. Equity shares are characterized as being the unit of capital of the organization. Each share issued by the company has a definite initial value known as the face valued of the share. Shares are units which are transferable in nature. The shareholders of the company are considered to be the owners of the company (Ogilvie, 1999, p.10). Dividends declared by the companies out of the profits generated from its business activities are the only source of income or return for the money invested by the shareholders of the company. The shares issued by a company are characterized by having different merits and demerits associated with it. Various advantages to the company management while raising funds through the issuance of shares by companies like Duke Plc. are: The fixed capital that is raised through this means does not result in the creation of any types of charges on the fixed assets of the company. The company does not have the obligation to repay the capital to its shareholders during its lifetime. It is required to be repaid only in the event of wound up of the company. The companies also do not have the liability of declaring dividends on shares for its shareholders and it is at the discretion of the company to take the decision of declaring dividends. The creditors and investors of the company gain confidence with the decision of the company to raise more capital through the issue of shares of the company. In spite of all these merits, equity share issued by the companies have its limitations too. They are: The issuance of more and more equity shares by a company results in the dilution of control and ownership rights of the existing owners of the company. The cost of equity is generally very high for a company because of higher expectations of returns by its shareholders. The costs related to the expenses incurred during the initial issue of shares to the public are also very high. Additionally, if only equity shares form the capital structure of the company then it would be devoid of the opportunity related to trading on equities. Preference Shares: Preference shares are instruments similar to ordinary shares which are issued by the companies to provide them with funds required for financing long term projects of the company. These types of shares are characterized by having a fixed percentage of dividends associated which the companies are required to pay before declaring dividends for the ordinary shareholders of the company (CCH, 2008, p.74). From the view point of Duke, Plc. preferences shares could be associated with its merits and limitations. Various merits of preference shares for the management of companies like Duke Plc. are as follows: The companies are not compelled to pay dividends to the preference shareholders in the events of company being unable to generate sufficient profits in a particular year. Those outstanding dividends could be carried forward to subsequent years but have to be paid to the preference shareholders of the company. The preference shareholders of a company do not have any type of voting rights like ordinary shareholders. Hence it proves to be advantageous for the company by not resulting in the dilution of control rights of the owners of the company. The preference share of companies which are not redeemable helps in the reduction of gearing of the company. The borrowing capacity of the company is not reduced through the issuance of preference shares because no other assets of the company are secured against it (Fao.org, n.d.). However, issuance of preference shares is associated with the following disadvantages: It is an expensive source of funds for the company because the dividends that are expected from it are quite high. For cumulative preference shares there is an existence of permanent burden. The creditworthiness of the company is reduced as a result of continuous delay in the payments of dividends related to preference shares of the company. Moreover there is no tax advantage for the company in the case of preference shares. Debt Financing The utilization of debt instruments for long term financing of projects in an organization like Duke could be advantageous for the company. The sources of debt financing for Duke Plc. could be either through long term loans or through issuance of debentures or bonds of the company. All forms of debt financing are characterized by having a fixed tenure of holding such capital by the companies. With the increase in debt financing, the requirement of equity financing for the company decreases. This results in increase in leverage or gearing of the firm (Crundwell, 2008, p.517). These are not the source of permanent capital of the company and have to be repaid after the completion of certain fixed periods. Long term Loans: Long term loans are mostly provided by the Financial Institutions (FIs) and banks to the different organizations. Long term loans are mostly repayable in a period of less than 10 years by a company. Most of the long term loans provided to the business organizations are characterized of being secured or mortgaged against the fixed assets possessed by the companies. The interest rates to be borne by the company depend on the creditworthiness of the companies. The companies have a definite obligation relative to the interest and principal repayments made by the companies. Debt financing through long term loans could be advantageous for Duke Plc. because of the following reasons: The interests associated with long term debts are tax deductible for the company. It does not result in the dilution of control of the owners of the company. The issuance cost of these types of debt financing method is quite low compared to other financing options available for the company. The future expenses that are required to be incurred by the company in relation to the interest payments are fixed in nature which helps in the protection of the company against high inflation rates in future. However financing through long term loans have its limitations too. The failure to fulfillments of fixed obligations that is created for the company in the form of interest and principal repayments can prove to be disadvantageous and can even lead to the bankruptcy of the company. The flexibility of the company management regarding its operational and financial performance activities are hindered as a result of these types of debt contracts undertaken by the company. There is a risk associated with the reduction in the inflation rates resulting in the cost of debt being higher in such situations. Debentures: Debentures are a means of long term financing of a company which are generally secured in nature. It can have either floating or fixed charges associated with it. Debentures are not issued by the FIs or banks but by general public (Gupta, 2011, p.105). Debentures that are issued by companies are comprised of different types like, secured, unsecured, convertible, non-convertible debentures, etc. Debentures if issued by Duke Plc. could prove to be beneficial for the company to raise funds for financing its long term projects. The merits of debenture issue can be summarized as follows: The company does not have to provide ownership rights to the debenture holders of the company. It proves to be a more reliable source of capital for the company compared to other financing options. The company gets the benefits of tax shield on the interest payments of debentures of the company. The investors also feel safe about investing in the debentures issued by the companies. It results in the increase of Earnings per Share (EPS) of the company. The company enjoys greater flexibility regarding the tenure and interest rates associated with the debentures issued by them. Issue of debentures are however associated with some of its limitations for the company too. They are summarized as given below: It results in a fixed obligation for the company in the form of regular interest payments by the company. In most of the cases it results in the creation of charges against the assets of the company. The cost of equity of the company gets enhanced as a result of the increased risk imposed on the investors of the company through the issuance of debentures of the company. The cost of issue for the debentures is also relatively high. Dividend Policy Dividends are issued by companies to its shareholders from the profits generated through its business activities (Arora, 2010, p.245). It is at the option of the company management to declare dividends in a particular year and it is not compelled to declared dividends for its shareholders. However the dividend policy adopted by a company can prove to be critical for its success and its long term sustainability. Hence dividends can actually be considered as the distribution of value of a public company like Duke Plc. to its shareholders. Various theories have already been developed in relation to the dividend policy adopted by a public company. Dividend Relevance Theory is one such important dividend theory which could be applied by Duke Plc. for its increased performance and success in future. The primary objective of Duke Plc. is to maximize the wealth of its shareholders. Duke Plc. being a public company needs to have an optimal dividend policy to have a sustainable growth in future. The dividend policy of the company is argued to have a direct relationship with the market value of the firm (Gitman, 2007, p.514). The share prices of Duke are also dependent on its dividend policy at a particular time. The preference of one dividend policy over another by the investors of the company depends on various factors. It depends on the primary motives of the investors about how they wish to receive the returns on their invested amounts in the company. Some argue that investors are only concerned about the aggregate returns that they receive and are not concerned about whether they receive it through dividends declared by the company or through sale of their shares generating capital gains for them. However, the relevance theory of dividend suggests that investors prefer one dividend policy over the other. This suggests that the dividend policy adopted by the company is relevant. It is mostly argued that the investors of a company are in favor of receiving current dividends rather than receiving capital gains because the current dividend payments made by the firm are characterized of being more certain than the capital gains to be received in future which are quite uncertain (Sheeba, 2011, p.329). Another important consideration is about the tax implications on the dividend payments received by the investors of the company. It depends on the preference and current situation of a particular investor regarding whether he wishes to take the tax burden now that is to be imposed on the current dividends received by him or if he wants to delay the tax payment by receiving capital gains on some future date and paying the tax imposed on it then (Besley, & Brigham, 2011 p.573). Hence the management of Duke Plc. needs to evaluate its dividend policy carefully so as to formulate an optimal dividend policy for the company. It needs to have a dividend policy which would ensure that a perfect balance is maintained between the future growth of the company by effective utilization of the retained earnings of the company and the current dividends to be paid out by the company. Conclusion Duke Plc. has been successfully running its business over the years. It has its presence all over the world and being a large organization it is required to finance a lot of its long term projects where huge amount of capital investment is needed. The company has both debt and equity financing options available to it for financing its long term projects. There are different instruments through which Duke Plc. can raise funds like shares, long term loans, debentures, etc. However, the company needs to strike a perfect balance between debt and equity financing options in its capital structure. Both these financing options have their own merits and demerits as indicated in this study. Hence the company needs to develop and maintain an effective and efficient capital structure so as to ensure its growth and success in future. Further, regarding its dividend policy, it has been found that the dividend policy of any firm has a direct relationship with its market value and is quite relevant to the company’s future prospects. Duke Plc. needs to have an optimal dividend policy which would ensure that its investors are happy and the market value of the company is enhanced. Above all the primary objective of Duke Plc. is the maximization of the wealth of its shareholders and thereby ensuring a sustainable growth in future. References Arora, M., 2010. Accounting and Financial Management. 3rd Ed. Meerut: Krishna Prakashan Media (P) Ltd. Besley, S., & Brigham, E. F., 2011. Principles of Finance. Connecticut: Cengage Learning. CCH, 2008. Australian Master Accountants Guide. Australia: CCH Australia Limited. Crundwell, F. K., 2008. Finance for Engineers: Evaluation and Funding of Capital Projects. Berlin: Springer. Fao., no date. Sources of Finance. [Online]. Available at: < http://www.fao.org/docrep/W4343E/w4343e08.htm#TopOfPage>. [Accessed on June 15, 2012]. Gitman, L. J., 2007. Principles of Managerial Finance. 11th Ed. New Delhi: Pearson Education India. Gupta, R. M., 2011. Project Management. New Delhi: PHI Learning Pvt. Ltd. Nos., no date. Sources of Long-term Finance. [Pdf]. Available at: . [Accessed on June 15, 2012]. Ogilvie, J., 1999. Treasury Management: Tools and Techniques for Countering Financial Risks. London: Kogan Page Publishers Sheeba, K., 2011. Financial Management. New Delhi: Pearson Education India. Read More