Options for corporations to raise capital

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Issue of long term financing

The financing is needed for 10 years which indicates that this is an issue of long term financing or capital structure. A firm's optimal capital structure is that mixture of debt and equity than minimizes its weighted average cost of capital (WACC). Since the after-tax cost of debt is lower than equity for many corporations, why not use debt only or mostly? It turns out that, while debt reduces a company's tax liability because interest payments are deductible expenses, increasing amounts of debt raise both the cost of equity capital and the interest rate on debt because of the increasing probability of bankruptcy. In other words, higher amounts of debt raise the financial risk of a company, and this risk is reflected on the cost of all the types of capital the company uses. As such, the relationship between financial leverage and WACC is not a straight line, but more of a U-shaped curve, with a minimum WACC between the extremes of debt utilization.

Apart from the risk associated with a firm's fundamental operations known as operating risk, risk can be introduced by the use of financial instruments with fixed payments, more commonly known as debt. Thus the advantage of taking debt is its lower cost, no share in profits. The limitation is that it increases financial risk. Hence the capital funding of a company is made up of two components: debt and equity. Lenders and equity holders each expect a certain return on the funds or capital they have provided. The cost of capital is the expected return to equity owners (or shareholders) and to debt holders, so WACC tells us the return that both stakeholders - equity owners and lenders - can expect. WACC, in other words, represents the investors' opportunity cost of taking on the risk of putting money into a company.

Equity Financing
Equity means sharing in the ownership. Thus this involves contribution by the owners of the organization. Equity can be raised either by private placement or by public. It has following features:

Claim on Income and Assets:
Shareholders have the claim on income and assets of the firm. Right to Control
Voting Rights
Pre-Emptive Rights
Limited Liability
(Pandey, I.M.)

Other ways of raising equity

Venture capital fund managers generally purchase equity of new businesses with the potential for rapid growth. Because of the very high risk ...