Financing Expenditures, Majority Shareholders & Attractive Bonds
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1. Discuss the advantages and disadvantages of financing capital expenditures through the use of internally generated cash. Cite cases where it is more effective and efficient to fund through internal funds and external funding sources; why would a financial manager choose one method over the other?
2. Find two publicly traded companies of your choosing. Look on the Internet for their financial information to see who the majority shareholders are for the corporation. Are they individual shareholders? Are they institutional shareholders (like mutual funds or pension fund organizations)? What are the implications of each type of majority shareholder with respect to the decision making that goes on at the firm?
3. If you were the CFO of a firm, what ways could you employ to make the issuance of your company's bonds more attractive in the market? In answering this question, research the current prices and bond yields of a few companies. Compare and contrast these yields with respect to what you perceive of the value of those companies.
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Solution Summary
Almost 1400 words investigate the pros and cons of financing capital expenditures via internally-generated cash, the type of majority shareholders in publicly traded companies and how to make company bonds more attractive in the market.
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1.
Discuss the advantages and disadvantages of financing capital expenditures through the use of internally generated cash. Cite cases where it is more effective and efficient to fund through internal funds and external funding sources; why would a financial manager choose one method over the other?
The major sources of financing capital expenditure are:
1) Debt
2) Equity
3) Preference shares
A firm's long-term success depends upon the firm's investments earning a sufficient rate of return. This sufficient or minimum rate of return necessary for a firm to succeed is called the cost of capital. The cost of capital can also be viewed as the minimum rate of return required keeping investors satisfied.
Thus the objective of the capital structure management is that mixture of debt and equity than minimizes its weighted average cost of capital (WACC). It has to optimally utilize the sources of finances which broadly are equity and Debt.
Let us discuss the pros and cons of using internally generated cash.
The benefits are:
1) There is no flotation cost involved unlike raising money through external funds.
2) This is the most easy and convenient way of raising resources
3) It does not involve the dilution of equity
4) Ownership is also not diluted unlike in case of external offer of equities
5) It does not involve increasing the financial risk unlike if the money raised through debt.
6) According to the pecking order theory the internal accruals are most preferred choice. Thus firms choose it according to the pecking-order hypothesis because of conservative mindset or out of some times compulsion in case of distressed firm.
The disadvantages are:
1) Using resources internally is costly as compared to the cost of debt and preferred securities
2) In short term it leads to reduction in return on equity.
3) It may lead to complacency in the management as its easy to raise and utilize. Thus this may lead to underutilization of resources.
4) Firm may not be able to dividend.
Cases where the external funds are chosen:
? When the firm is in rapid growth phase and cash reserve are not enough to fund the capital expenditure.
? When they want to leverage on the equity by raising the debt and thereby reducing the overall cost of capital.
? When the external markets are favorable
? When the firm has stable dividend policy
Cases where the internal funds are chosen:
? When the firm has enough cash reserve to utilize ...
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