Financing Decision

6 Key excerpts on "Financing Decision"

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  eBook - ePub

  Accounting and Finance for Managers

  A Decision-Making Approach

  • Matt Bamber, Simon Parry(Authors)
  • 2017(Publication Date)
  • Kogan Page

    (Publisher)

  10

  Financing Decisions

  OBJECTIVE To provide an understanding of the different sources of finance available to businesses and the theoretical and practical factors that underpin Financing Decisions.

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  LEARNING OUTCOMES After studying this chapter, the reader will be able to:

  • Differentiate and evaluate the different sources of finance available to a business.
  • Understand the relationship between risk and return and the need for a range of finance products that offer a range of risk levels.
  • Identify and evaluate appropriate financing strategies.

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  KEY TOPICS COVERED

  • Types of equity finance.
  • Types of debt finance.
  • Calculating the cost of capital.
  • The capital structure decision.
  • Practical considerations of raising finance.

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  MANAGEMENT ISSUES

  Managers need to appreciate the range of sources of finance available to a business and to distinguish which sources are the most appropriate for a given situation. They need to understand the impact that financing can have on the profitability of the business.

  Introduction

  This chapter is concerned with the capital structure decision of a business. It addresses one of the fundamental questions of financial management, which is: ‘How should a business be financed?’ In this chapter we address this question firstly by identifying the different sources of finance available and then by examining the factors that determine the optimum mix of finance.

  Fundamental dynamics of finance: risk and return

  Both investors, that is to say the providers of finance, and those seeking to raise finance will be looking for the best deal they can obtain. Such a deal will be measured in terms of the risk and returns involved. By risk, we mean the risk that the expected level of return is not received. For the investor, the highest level of risk is that not only is a financial reward not received from the investment, but also the amount invested is lost. Return is normally measured as a percentage of the initial investment. For example, if you invest $100 and receive $120 in one year, you have received a 20% return ($20/$100).

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  Financial Management

  An Introduction

  • Jim McMenamin(Author)
  • 2002(Publication Date)
  • Routledge

    (Publisher)

  part five Strategic Financial Decision-Making The Financing Decision

  Part 5 Contains the Following:

  •	Chapter 13 - Capital Structure and Gearing
  •	Chapter 14 - Dividend Policy
  •	Case Study 5 - PolyStores plc

  In this part we continue our exploration of the financial decision-making stage of the financial management process by examining the firm's strategic Financing Decisions.

  Part 4 demonstrated that there is a clear and direct connection between a firm's strategic investment decisions and its value. As we will see, whether a firm's strategic financing (capital structure and dividend) decisions have any impact on its value is a highly controversial area in financial management.

  For example, some theorists argue that there is no connection between capital structure decisions and value, or between dividend decisions and value. They contend that these decisions are irrelevant when it comes to determining the value of the firm. These are the issues which this part examines.

  Chapter 13 examines the nature of the firm's long-term capital structure decisions and how they impact on its value.

  Chapter 14 reviews the firm's dividend policy, which is an essential part of its strategic financing arrangements, and also examines its connection with a firm's value. Part 5 concludes with a case study on strategic planning.

  Part 5 diagram The financial management process: financial decision-making — the Financing Decision

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  13 Capital Structure and Gearing

  Learning Objectives

  By the end of this chapter you should be able to:

  1. understand the meaning of capital structure;
  2. explain the various models of capital structure;
  3. use the M&M model to determine a firm's cost of capital and its market value;
  4. understand the practical considerations influencing capital structure;
  5. determine a firm's financial, operating and total gearing.

  Capital Structure Fundamentals

  Capital structure refers to the combination of debt and equity capital which a firm uses to finance its long-term operations. Capital in this context refers to the permanent or long-term financing arrangements of the firm. Debt capital therefore is the firm's long-term borrowings and equity capital is the long-term funds provided by the shareholders, the firm's owners. Capital structure is illustrated in Figure 13.1

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  Financial Management Practices in India

  • Sandeep Goel(Author)
  • 2016(Publication Date)
  • Routledge India

    (Publisher)

  Part III Financing Decision Passage contains an image

  8 Capital Structure Planning and Policy

  DOI: 10.4324/9781315658896-11

  Introduction

  The financing policy decision is deciding about the capital structure of the firm. A firm tries to have an optimum capital mix of debt and equity for shareholders’ wealth maximisation. The weighted average cost of capital (WACC) is helpful in capital budgeting decisions. It is used as a discounting rate in calculating the NPV and IRR of a project and thus determines whether a company should go ahead with a project or not. Every firm tries to minimise its WACC by employing a suitable mix as a firm with lower WACC can more easily return profits to its owners.

  The Financing Decision involves a consideration of three principal responsibilities of a finance manager. These are

  1. estimation of total financial requirements for the business enterprise;
  2. identification of sources of finance and determination of financing mix; and
  3. cultivating sources of finance and raising the required finance.

  In other words, it covers two interrelated aspects, namely:

  1. determining an appropriate financial/capital structure; and
  2. raising the required amount of funds.

  Capital structure defined

  The assets of a company can be financed by increasing either the owners’ claim or the creditors’ claim. The owners’ claim increases when the firm raises funds by issuing ordinary share or by retained earnings; the creditors’ claim increases by borrowing. The various means of financing represent the financial structure of an enterprise. The left-hand side of the balance sheet (liability plus equity) represents the financial structure of a company. Traditionally, short-term borrowings are excluded from the list of methods of financing the firm’s capital expenditure, and therefore, the long-term claims are said to form the capital structure of the enterprise.

  Capital structure

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  Applied Corporate Finance

  • Aswath Damodaran(Author)
  • 2014(Publication Date)
  • Wiley

    (Publisher)

  C HAPTER 7 C APITAL S TRUCTURE : O VERVIEW OF THE F INANCING D ECISION Learning Objectives 7.1. Review the various debt, equity, and hybrid financing options available to firms. 7.2. Explain how and why a firm’s choice of financing should change as it moves through the life cycle. 7.3. Describe the process by which a firm makes the transition from one financing stage to another across the life cycle. 7.4. Analyze the benefits and costs of financing with debt. 7.5. Examine the argument that there is no optimal mix of debt and equity for a firm. M AXIMIZE THE V ALUE OF THE B USINESS (F IRM ) The Investment Decision Invest in the assets that earn a return greater than the minimum acceptable hurdle rate The Financing Decision Find the right kind of debt for your firm and the right mix of debt and equity to fund your operations The Dividend Decision If you cannot find investments that make your minimum acceptable rate, return the cash to owners of your business The hurdle rate should reflect the riskiness of the investment and the mix of debt and equity used to fund it The return should reflect the magnitude and the timing of the cash flows as well as all side effects The optimal mix of debt and equity maximizes firm value The right kind of debt matches the tenor of your assets How much cash you can return depends on current and potential investment opportunities How you choose to return cash to the owners will depend on whether they prefer dividends or buybacks 284 The Choices: Types of Financing 285 In the past few chapters, we argued that projects that earn a return greater than the minimum acceptable hurdle rate are good projects. In coming up with the cost of capital, which we defined to be the minimum acceptable hurdle rate, however, we used the existing mix of debt and equity at the firm. In this chapter, we examine the choices that a firm has in terms of both debt and equity and how these choices change over a firm’s life cycle.

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  Managerial Finance

  • Alan Parkinson(Author)
  • 2012(Publication Date)
  • Routledge

    (Publisher)

  Part II The Financing Decision Passage contains an image

  3 Finding finance

  Introduction

  Part I established that the management of financial resources has a strategic dimension in addition to the day-to-day operational perspective. This strategic dimension requires managers and their specialist financial advisers to have an appropriate strategy to ensure that:

  • a suitable value of funds is available to and within the organization
  • as and when required
  • at the minimum cost possible.

  This in itself is a challenge – a challenge which is compounded by the very real fact that at any one time there is available more than one single source of finance. Indeed there are many sources, each with different features and, importantly, different costs. Cost minimization too will play a major role within the challenge, and complicate matters, thus presenting an even greater challenge.

  This challenges managers within the organization with the task of selecting not just one source but possibly of blending together a mixture of the various available finance types, with a view to achieving an optimum package of finance. This challenge is made even stiffer by the fact that trying to achieve an optimum package is a dynamic process. It is dynamic in the sense that it is constantly under review as:

  • new demands for additional and/ or replacement funding appear
  • new types of funding sources become available
  • changes occur within the organization’s operating practices.

  It is essential that every opportunity is taken to ensure that the mix of financing is the most appropriate in light of this dynamic process. In this chapter you will examine the characteristics of differing types of finance sources and the significance of each type within the Financing Decision. By the end of this chapter you will:

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  Essentials of Corporate Finance

  • Robert Parrino, David S. Kidwell, Thomas Bates(Authors)
  • 2013(Publication Date)
  • Wiley

    (Publisher)

  That discussion focused on individual sources of capital. In this chapter, we focus on the choice between various types of financing. In particular, we examine how a firm’s value is affected by the mix of debt and equity used to finance its investments and the factors that managers consider when choosing this mix. Managers use the concepts and tools discussed in this chapter to make financ- ing decisions that create value for their stockholders. We begin with a discussion of two propositions that provide valuable insights into how the choice between debt and equity financing can affect the value of a firm and its cost of equity. These insights provide a framework that we then use to examine the benefits and costs associated with using debt financing. We next describe and evaluate two theories of how managers choose the appropriate mix of debt and equity financing. Finally, we discuss some of the practical considerations that managers say influence their choices. CHAPTER PREVIEW 1 These are the types of securities that firms issue to finance the assets that they purchase. However, it is important to recognize that firms do not purchase all assets they use. Many assets that businesses use are leased (rented). A lease (rental) agreement can enable a business to obtain the use of an asset without purchasing it and, consequently, the asset and its associated lease financing might not show up on the company’s balance sheet. Also, since business lease agreements generally require no deposit, they essentially represent 100 percent debt financing. For these reasons, the decision to purchase or lease an asset is directly related to the capital structure choices that managers make. The appendix to this chapter discusses lease agreements and how managers choose between buying and leasing an asset. 14.1 CAPITAL STRUCTURE AND FIRM VALUE As you know, a firm’s capital structure is the mix of debt and equity used to finance its ac- tivities.

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