Options for Sourcing Funds - Assignment Example

Capital Budgeting Evaluation Student’s Name Instructor Institution Course Date Options for Sourcing Funds The organizations always have various reasons for sourcing the funds in which the major one is to acquire the capital assets. Such assets include the new machinery or even construction of new building. New product development may be costly to the extent that it calls for the requirement of the capital. In most cases, the productions of the new products get their finances internally while the money used to acquire the machinery always come from the external sources (Ghosh & Van Tassel, 2011). Nowadays, the business is in the ages of the tight liquidity. For that matter, most of the organizations look for the short-term capital in the form of loans and overdrafts to provide the cash flow cushion. Thus, this paper seeks to discuss the various sources of the finances that are available to the TNA management, both external and even the internal. It will also give the advantage and the disadvantages of various sources of the funds. Lastly, the paper will make the TNA management to understand that govern the choice among different sources of the funds. The company may raise the new funds from various sources such as the capital markets. The first source of the funds is the ordinary or the equity shares. The ordinary shares are the shares that are issued to business owners. In the capital markets, the company will issue new shares by acquiring the market listing of the stock for the first time. The company may also issue the rights as the source of the fund in the capital market (Bierman & Smidt 2012). Other sources may include the loan stock, the retained earnings, the government sources, the bank borrowing, the franchising, the venture capital, and even the funds from the business expansion scheme. TNA management may opt to issue the ordinary shares to the owners of the company. The TNA management may choose to raise the fund from the loan stock. The loan stock is the capital from the long-term debt that the company raises and it will have to pay with some interests. In this situation, the holders of the loan stock become the long-term creditors of the firm (Brooks & Mukherjee 2013). The loan stock I am always having the nominal value and it is the debt that the company owes. The company then pays the interest at the couple stated yield. The best example for the loan stock is the debentures. They are defined legally as written acknowledgment of the debt that the company incurs. It contains the provisions concerning the payment of the interest and eventual repay of the capital. Another source of the fund that may assist the TNA management to raise the required finance is the bank lending. The bank borrowings are the crucial sources of the funding for the companies. The bank credit always comes in the form of the short-term loans. The short-term lending is always in the following ways. The first form is the overdraft that the company needs to keep within the limit that the bank has set. Another form is the short-term loans that are lend for a maximum period of three years. The banker will have to consider different factors such as the purpose, the repayment, the amount, the security, and even the term. The next option, where the TNA management may acquire the finance, is through leasing. The lease is the agreement between the two parties, which include the lessee and the lessor. The lessor owns the capital asset yet he or she allows the lessee to use it. The lessee will have to make the payments according to the terms given for particular period. The forms of the lease include the operating leases, which are the rental agreements that are between lessor and lessee. Another form is the financial issue, which are the lease agreement between users of leased asset and the provider of the finance (Brooks & Mukherjee 2013). The responsibility of the lease is for the upkeep, maintenance, and even the servicing of assets. Lease always have the primary period that cover most or even all of economic lifespan of that asset. The TNA management may go for the Hire purchase as another alternative for the sources of the required funds. The hire purchase is the form of the instalment credit. It is similar to the leasing. The only exception is that the ownership of goods passes to the customer of the hire purchase on the payment of final credit instalment. However, the lessee never becomes the owner of goods. The hire purchase agreements involve the financial house. The company may use the hire purchase as the source of the funds. With the industrial hire purchases, the business customers will have to obtain the finance f the hire purchase from the financial house to buy fixed assets. The goods that the company may buy through the hire purchase included the machinery and even office equipment. Another option for the source of the capital fund for the organization is the venture capital. The venture capital is the money that is put into the enterprise that may be lost in case the enterprise fails (Brooks, & Mukherjee 2013). The company will have to invest the venture capital when it needs an extra funding from the source apart from the individuals’ pocket. Venture capital is associated mostly with the issue of putting the funds in returns for the equity stake, the new business, the management buy-out, or even the major schemes of expansions. The company may also use the franchising as another alternative to the source of the finance. Franchising refers to the method used to expand the business on the less capital than the way in which an individual would otherwise need. For a suitable business, franchising is another alternative that can be used to raise the extra capital for the growth of the enterprise. Under the franchising arrangement, the franchisee will pay the franchisor for the right of operating the local commercial activities using the franchisor's trade name. The franchisor must bear accurate costs such as the legal fees, establishment costs, the marketing costs, and even the costs of the support services (Brooks & Mukherjee 2013). The franchisor will also charge the franchisee the initial price for the franchise so that it may cover the set-up costs. Another source that the company may go for so that it may raise the required capital is through the retained earnings. For the organization, the earnings that are retained within the business have the direct influence on the dividends amount. The profit that the company has earned from its operations is being employed to finance other new investments instead of dividing it among the business owners as the dividends. Thus, the company will be in the position of raising the new equity for new investments. The last option that the TNA management may go for to seek for the funds is through the government assistance. The government will provide the finance to the companies in the cash grants and any form of the direct assistance. It constitutes the section of the policy that involves in assisting in developing the economy of the nation. It happens mostly in the industries that employees the high technologies and even in the areas of the unemployment. TNA management may get sufficient funds that it requires by employing those options provided for the fund sourcing (Churm, Radia, Leake, Srinivasan, & Whisker 2012). The company may decide to pick one of the options or even combining those options of raising the funds. Thus, within a short period, the company will be in the position of raising the capital that it needs. Hence, it will acquire the total amount required to purchase the business and machinery. Question Two In a case where and organization would wish to make expenditures that involve cash flow benefits for more than one year then this case is referred to as the capital expenditure (Julián & Andrés Mauricio 2014). A very good example that involves capital expenditure is the problem in question where the TNN Company has got the opportunity to buy new equipment for processing food and packaging industry. In most cases, capital expenditure involves a huge cash outlays with a lot of implications on the future values of the firm hence it is very important to carry out capital evaluation before the proposed project is implemented (Hogaboam & Shook 2004). Other examples that involve an expenditure of the capital may be in areas like purchasing another company, obtaining new technologies and even expansion of the existing production facilities. This paper seeks to evaluate the capital expenditure of the TNA Company that is considering buying a majority interest in a small local firm that manufactures food processing equipment and equipment for packaging. Capital budgeting analysis involves evaluation of how an organization invests in the capital assets for example how the organization invests in the assets that provide cash flow benefits for a relatively longer period that is more than one year---the question that needs an answer when evaluating budget of any organization or firm is whether the future benefits of the investment will be good enough to justify the project following the involved risks. It is very important to note that how the business currently spends its money determines the value of that business in the future. Therefore, the management of the TNA firm should have their attention focused on the present values of the business so that they can understand how their current expenditure may influence their future value (Simkins 2011). A very common method that firms use to evaluate their present value of the project is the discounted cash flow even though the approach is too narrow. Evaluation of the capital budget of any firm may involve looking at the following issues: analysis of the decisions so as to build the knowledge, determining the option pricing policies so as to determine the position of the firm. In addition to these two issues, a firm may consider looking at the discounting cash flow so as to make rational investment decisions Analysis of the Investment Decision The process of decision making by most firms is increasingly becoming complex mainly because of the available risks and uncertainties since most of the capital projects involves a lot of variables (CHADWELL-HATFIELD, et al. 2007). Determining the cash flow of a project involves working capital requirements, consideration of the changes in the inflation rates, risks associated with the project and even the values of the project in case of its disposal. To establish food processing plant, the TNA should consider working on their operational costs capacity utilization by the firm and even other additional costs so as to fully understand the markets to forecast their revenues (TRUONG et al. 2008). DCF = CF1/ (1+r) 1 + CF2/ (1+r) 2 + CF3/ (1+r) 3 ...+ CFn/ (1+r) n Where: CF1 = cash flow in period 1 CF2 = cash flow in period 2 CF3 = cash flow in period 3 CFn = cash flow in period n r = discount rate DCF= 200000/ (1+4/100)1 + 200000/ (1+3/100)2 + 200000/ (1 + 2/100)3 + 200000/ (1+2/100) 4+ 200000/ (1+2/100)5 = 200000/ (1.04)1 + 200000/ (1.03)2 + 200000/ (1.02)3 + 200000/ (1.02)4 + 200000/ (1.02)5 =192307.69 + 188519.18 +188464.47 + 184769.09 + 181146.16 = $935207.6 Given that the future cash flow of the TNA investment is amounting to $935207.6 (positive) then it is worth investing in this kind of a project. Based on the above evaluation, TNA management should try to the investment with a positive net present value because in doing so, the management is enhancing the market value of the project and also increasing the wealth of the stakeholders. It is advisable for the management of the TNA firm not just to pick up an investment because it looks financially attractive. For success in capital investment is directly linked to the extent to which the organization establishes measures is geared towards the achievedment of strategic objectives of the business (Chalos & Poon, 2000). Rates of Return Rates of returns refer to measures that are used by the business organization like TNA firm to determine the future profits that can be realized from an investment (that is it is a profit measure as a percentage of the investment). Rates of return for TNA investment will be affected by the rates of inflation and exchange rates that have a direct influence on the future profits of the organizations investment. Compounded annual growth rate is one of the rates of return measures that TNA Company can adopt to determine the rate at which the investment is growing annually for five years. CAGR = BV (1-r/100) n Or CAGR= (EV/BV) 1/n - 1 Where: EV = the investment's ending value BV = the investment's beginning value n = Years For example if TNA invest $10000000 then the portfolio of the business (investment) over a period of five years will be like: Year 1= 120/100 X 10000000 =12000000 Year 2 = 130/100 X12000000 = 15600000 Year 3= 130/100 X 15600000 = 20280000 Year 4 = 120/100 X 20280000 =24336000 Year 5= 110/100 X 24336000 =26769600 When the business venture of TAN Company finishes five years then it shall make a profit of (26769600-10000000) $16769700 and; therefore, it is strongly recommended that the TNA firm consider investing in this type of business because it has positive returns. In a situation where the required investment capital was $7 million then the profits or return would be relatively smaller as the risk of investment shall have reduced. When the business venture is riskier, then the probability of making greater returns is higher than less risky business ventures. It is advisable for the management of the TNA Company to focus mainly on the financial attractiveness of the business venture because the primary reason for any business is to make profits. Bibliography Bierman Jr, H, & Smidt, S 2012, “The capital budgeting decision: economic analysis of investment projects.” Routledge. Brooks, R., & Mukherjee, A. K. (2013). Financial management: core concepts. Pearson. Chadwell-Hatfield, P., Goitein, B., Horvath, P. & Webster, A., 2007. Financial criteria, capital budgeting techniques, and risk analysis of manufacturing firms. Journal of Applied Business Research, 13(1), pp. 95-104. Chalos, P. & Poon, M., 2000. Participation and performance in capital budgeting teams. Behavioral Research in Accounting, Volume 12, pp. 199-229. Churm, R, Radia, A., Leake, J, Srinivasan, S, & Whisker, R 2012, “The funding for lending scheme” Bank of England Quarterly Bulletin, Q4. Ghosh, S, & Van Tassel, E 2011, “Microfinance and competition for external funding,” Economics Letters, 112(2), 168-170. Hogaboam, L & Shook, S, 2004. Capital budgeting practices in the U.S. forest products industry, Forest Products Journal, 54(12), pp. 149-158. Julián, O. & Andrés Mauricio, M., 2014. Capital budgeting practices: Empirical evaluation of company practices in the construction sector in Colombia. Ecos de Economía, 18(39), pp. 143-163. Simkins, B., 2011. Total Risk Evaluation for Capital Budgeting. Journal of Applied Finance, 21(1), pp. 30-38. Truong, G., Partington, G. & Peat, M., 2008. Cost-of-Capital Estimation and Capital-Budgeting Practice in Australia. Australian Journal of Management, 33(1), pp. 95-121. Read More

Another form is the short-term loans that are lend for a maximum period of three years. The banker will have to consider different factors such as the purpose, the repayment, the amount, the security, and even the term. The next option, where the TNA management may acquire the finance, is through leasing. The lease is the agreement between the two parties, which include the lessee and the lessor. The lessor owns the capital asset yet he or she allows the lessee to use it. The lessee will have to make the payments according to the terms given for particular period.

The forms of the lease include the operating leases, which are the rental agreements that are between lessor and lessee. Another form is the financial issue, which are the lease agreement between users of leased asset and the provider of the finance (Brooks & Mukherjee 2013). The responsibility of the lease is for the upkeep, maintenance, and even the servicing of assets. Lease always have the primary period that cover most or even all of economic lifespan of that asset. The TNA management may go for the Hire purchase as another alternative for the sources of the required funds.

The hire purchase is the form of the instalment credit. It is similar to the leasing. The only exception is that the ownership of goods passes to the customer of the hire purchase on the payment of final credit instalment. However, the lessee never becomes the owner of goods. The hire purchase agreements involve the financial house. The company may use the hire purchase as the source of the funds. With the industrial hire purchases, the business customers will have to obtain the finance f the hire purchase from the financial house to buy fixed assets.

The goods that the company may buy through the hire purchase included the machinery and even office equipment. Another option for the source of the capital fund for the organization is the venture capital. The venture capital is the money that is put into the enterprise that may be lost in case the enterprise fails (Brooks, & Mukherjee 2013). The company will have to invest the venture capital when it needs an extra funding from the source apart from the individuals’ pocket. Venture capital is associated mostly with the issue of putting the funds in returns for the equity stake, the new business, the management buy-out, or even the major schemes of expansions.

The company may also use the franchising as another alternative to the source of the finance. Franchising refers to the method used to expand the business on the less capital than the way in which an individual would otherwise need. For a suitable business, franchising is another alternative that can be used to raise the extra capital for the growth of the enterprise. Under the franchising arrangement, the franchisee will pay the franchisor for the right of operating the local commercial activities using the franchisor's trade name.

The franchisor must bear accurate costs such as the legal fees, establishment costs, the marketing costs, and even the costs of the support services (Brooks & Mukherjee 2013). The franchisor will also charge the franchisee the initial price for the franchise so that it may cover the set-up costs. Another source that the company may go for so that it may raise the required capital is through the retained earnings. For the organization, the earnings that are retained within the business have the direct influence on the dividends amount.

The profit that the company has earned from its operations is being employed to finance other new investments instead of dividing it among the business owners as the dividends. Thus, the company will be in the position of raising the new equity for new investments. The last option that the TNA management may go for to seek for the funds is through the government assistance. The government will provide the finance to the companies in the cash grants and any form of the direct assistance. It constitutes the section of the policy that involves in assisting in developing the economy of the nation.

Read More