Table of Contents
1.1. Possible sources of finance.
1.2. Cost of each source of finance.
1.3. Opportunity cost and tax implications.
1.4. Information needed for the CEO to make a decision.
2.1 The factors affecting the decision-making process of CEO in raising capital
2.2 Suitable method.
2.3 WACC calculation for the project
2.4. Control dilutions.
2.5. Impact of finance.
Appendix 1: Balance Sheet In The First Half 2014.
List of figures
Figure 2. 1: Operating results of Alphanam over five years 2009 – 2013.
Alphanam (stock code: ALP) is a company that has been nominated as the reputational milk producer in Vietnam. This report is based on the official public financial statement of ALP in the first half of 2014 for up-to-date information. The author has prepared a report on possible sources of finance that are available to the company to mobilize funds from both internal and external sources. In addition, this report also mentions the pros and cons of financing by debt and equity. Each method has its own advantages and disadvantages. Therefore, the company must make the decision on the method of financing or the source of financing which is the most tailor-made for the company and in response to the external environment.
1.1. Possible sources of finance
According to Winton and Yerramilli (2008), a company has many options to mobilize funds from either internal or external sources to finance its working capital, investments, and/or projects that deliver positive results.
The first and foremost possible source of finance is from the internal source. The company can have its own capital to finance its business operations, business expansions, working capital, or projects (Ross, 2012). In addition, if the company reports a profit and the retained earnings or profit has not been distributed to shareholders, the company can use this source of finance to finance its projects, business operations, and business expansions. The shareholders may not be provided with dividends. However, they can expect a higher return in the future from the company thanks to its intensive investments (Guariglia, et al., 2011).
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The second possible source of finance is from the external source. In particular, ALP can be financed by a loan or equity. The loan can be taken from a certain bank, the issuance of bonds, and/or other non-bank creditors in short-term or long-term period (Ross, 2012). When the Company issues bonds, the bondholders who buy bonds from the company will become the company’s creditors. The company is mandatory to pay a fixed income in each bond. Conversely, the equity can be taken from the issuance of shares to shareholders. The shareholders will not gain fixed income and the returns received by shareholders will vigorously depend on the business performance of the company and the dividend payout policy of each company (Kregel, 2004).
1.2. Cost of each source of finance
- Debt financing
Financing business operations by a loan: It means the company has to pay the fixed income for the bondholder in a certain period of time specified by the company. It means that ALP must pay interest expense for the bond issuance. It is considered as the cost of debt via the issuance of bonds. Similarly, if the company also takes a bank loan, the company also has to pay the interest expense for the bank loan in the loan term (Duran, 1952; Binsbergen et al., 2010).
- Equity financing
Financing business operations by equity: when ALP decides to finance its business operations by equity, it means that the company is poised to issue shares to shareholders (Duran, 1952; Ross, 2012). Cost of equity may include dividend payment, fee-related to disclosure information, commission, retained earnings costs, etc. The shareholders will not receive the fixed income as bondholders do. The shareholders’ dividends will heavily depend on the dividend payout ratio of the company and the company’s business performance. Therefore, the cost of equity cannot be fixed as the cost of debt (Dhaliwal et al., 2005).
1.3. Opportunity cost and tax implications
- Opportunity cost
The opportunity cost for the source of finance by equity is the cheaper source of finance by a loan. It means the interest expense for a bank loan or the fixed income paid for bondholders is the opportunity cost for the source of finance by equity (Ross, 2012).
It should be noted that a high gearing ratio (high debt ratio) is preferred by the company’s shareholders because it is the tax shield for the shareholders to earn higher profitability (Rajan and Zingales, 1995; Deesomsak et al., 2009). However, the high gearing ratio is not preferred by the company’s creditors because it shows the company is likely to take higher credit risk with its debts (Watson and Head, 2007)…………..