Capital Finance or Equity and Debt - Case Study Example

Financing Toyota’s debt One of the best ways to finance Toyota’s needs would be to raise funds from the capital markets, through the issue of freshshares in the market. Toyota shares are currently valued at $123 per share (www.investing,businessweek.com). As of July 20, 2007, Toyota had 3,609,997.492 shares issued (and it may be possible to raise a substantial amount of money through the issue of shares. However, in order that the ownership of the Company is not affected, it may be better for Toyota to consider a rights issue, so that shareholders with more than four shares could be offered two additional shares, at a slightly reduced price of $120 per share. This would ensure that the price is slightly lower than the prevailing market rate in order to attract the existing shareholders while at the same time, ensuring that the price per share is not diluted too much in the market. The number of Toyota shareholders as of 2004 were 339,549 (www.toyota.co.jp), Therefore it may be assumed that at least 300,000 shareholders may be interested in coming forward to subscribe for new shares, since the Company has also been posting profits recently and has been doing well. This will generate a revenue of $72 million, which can be raised without much risk. A rights issue allows existing shareholders the opportunity to subscribe cash for new shares, in proportion to their existing holdings. Toyota can also consider the issue of new preference shares at a price of $240 per share. Since there are about 4000 corporate entities and about 1200 non individuals who are owners of shares in the Toyota Corporation (Stock Overview), it is likely that these corporations may also be interested in coming forward to purchase preference shares. Toyota could consider issuing about 900,000 preference shares which will generate an additional revenue of $ 216 million. Raising funds through share capital is a form of equity financing. The advantages of equity financing are the fact that some degree of ownership in the firm is exchanged for financing, however there is no interest to be paid on funds raised in this manner, therefore the risks involved are lower.(www.business.ml.com). The issue of preference shares is an especially viable option for Companies to raise funds, because dividends do not have to be paid on such shares during a year when profits are low, however in the case of loans, interest must be regularly paid irrespective of whether the Company has a good or bad financial year. Moreover, since preference shares do not carry voting rights, the ownership of the Company will not be diluted while more funds are raised to cover the expenses of recall of the vehicles affected by the defective steering mechanism. Another advantage with the issue of preference shares is that Toyota’s power to borrow funds will not be restricted in any way, and non payment of dividends will also not give the shareholders the right to appoint a receiver, as in the case of debenture holders. Therefore, the question of equity financing offers several attractive advantages to Toyota as a means of financing its current cash requirements. Another source of equity financing that could be considered by Toyota is the issue of loan stock. This is a form of long term debt capital which the Company can raise, on which it will have to pay some interest, however the interest rates will be minimal, since the holders of loan stock will be equivalent to long term creditors of the Company; the loan stocks being issued over a long term period. It is proposed that the Toyota Company may raise about $400 million through the issue of loan stocks, because it may have to pay half yearly interests on these amounts at about 10% of the nominal value of the stock, which will amount to $40 million payable over a six month period. Since Toyota sales are likely to pick up again once the recall is over, the temporary funds crunch situation could be alleviated within that time so that these stock holders can be paid. Toyota could even consider paying these investors a yearly interest rate. The funds can be secured in this manner for a long term period of ten years, before they need to be repaid and they will not be subject to the huge rates of monthly interest that Toyota will be saddled with if it opts to go for debt financing for the entire amount of $975 million. In securing the funds it needs, it is not recommended that Toyota go entirely for equity financing. Firstly, there is only a limited amount that Toyota can raise in this manner, because every issue of stock/shares compromises the extent of ownership of the Company and makes the ownership more diffuse, which in turn will produce problems in levels of controls exerted by stockholders and interference with the functioning of the Company. The total amount of equity finance that has been suggested amounts to $76 million + $216 + $400 million = $692 million. The balance of amount which still needs to be raised is $975 million - $692 million = $283 million. However, by raising $692 million by way of issue of shares and stock, Toyota will be able to strengthen its balance sheet and demonstrate a stronger financial position (www.business.ml.com), which could make it eligible to receive a short term loan from a bank to covert the remaining amount that it still needs to raise. Since Toyota has an excellent operating history and has recorded profits for several years, it will be able to show financial strength, especially when combined with the ample assets it now possesses by way of equity financing and issue of shares. The rates of interest offered on business loans varies depending upon the element of risk that is involved as well as the time period that is sought to repay the loan. In the case of business loans taken for a period of 6 to 84 months for purposes of business refinancing or purchases, the rates of interest vary from 8.25 to 10.25%. (www.economywatch.com). By taking a temporary loan from a bank for the amount of $283 million which it requires, Toyota can opt for a three year repayment period, which would provide it adequate time to recover its monies from its business and pay back the loan, while also simultaneously ensuring that the interest rates charged are minimal, especially because the Company has historically been in a strong financial position. Conclusion: Therefore in conclusion, the following financial plan is suggested for raising $975 million. Equity Financing: (a) A Rights Issue of 600,000 common shares to raise an amount of $76 million dollars (b) An issue of 900,000 preference shares to yield an amount of $216 million dollars (c) Issue of loan stocks, to raise $400 million Debt Financing: (a) Through a bank loan for the amount of $283 million for a period of three years at an interest rate of 8.25%. It is therefore recommended that Toyota use a combination of debt and equity financing to generate cash for its current requirements. While relying solely on debut financing would mean payments of large amounts of interest which makes it an unviable option, relying completely on equity financing is also not to be recommended. This results in a compromising of the ownership and control in the Company which in the long run, will be detrimental to its efficiency of operations. References: * Business loan interest rates. [online] available at: http://www.economywatch.com/business/business-loan-interest-rate.html * Choosing between debt and equity [online] available at: http://www.business.ml.com/BCPublic/Financing/Resources/ArticlesAndTips/Article20050705ChoosingBetweenDebtAndEquity.htm * Share Information, 2004. [online] available at: http://www.toyota.co.jp/en/ir/library/annual/pdf/2004/19.pdf * Stock Overview. The Toyota Corporation [online] available at: http://www.toyota.co.jp/en/ir/stock/outline.html * Toyota Motor Corp. [online] available at: http://investing.businessweek.com/research/stocks/ownership/ownership.asp?symbol=TM * Toyota Motor Corporation: No: of listed shares. [online] available at: http://www.investegate.co.uk/Article.aspx?id=200707200811575874A Read More