What Finance Options Are Open to a Fast-Growing UK Listed Maritime Company - Assignment Example

? What Finance Options Are Open to a Fast Growing UK Listed Maritime Company That Is Looking to Expand? Introduction Listed companies refer to companies which equity is recognized by a stock exchange such as the London Stock Exchange. Listed companies usually bear a value placed on their equity as their shares are traded through the exchange system. Running a successful business operation requires effective financing as access to finance is critical to the company’s growth and productivity. Most companies can obtain the financing they need, although there are a number of structural market failures constraining both debt and equity financing. The market failure may arise from imperfect information fuelled by volatile economic conditions where lenders become risk averse. #1 Critical evaluation of the difference between debt and equity from the perspective of a UK listed company Listed companies have a broad range of financing options available to them, which include debt and equity (Graham and Smart, 2009, p. 44). Companies utilize a blend of debt and equity funding to finance their operations. Companies bearing high credit ratings can borrow money at low interest, besides selling shares at a premium. Debt refers to money raised from banks and bondholders, while equity refers to money raised from the shareholders. In return for investing their money in a company, shareholders are rewarded with a percentage of the company (a share). Equity financing refers to issuing additional shares of common stock to investors. The issuing of common stock decreases the previous stockholders’ percentage of ownership. Debt financing is often accompanied by strict conditions or covenants, besides having to pay interest and principal on stipulated dates. Debt Sources of Financing Debt financing incorporates collateralized bonds, leases, bank overdrafts, debentures, lines of credit, and bank loans. A bond refers to a written promise to pay back a certain amount of money on a stipulated date in the future. In the interim, bondholders receive interest payments at fixed rates on stipulated dates. Debt financing typically includes an interest rate of about 3-8% depending on the debt and the arrangement. The face value, maturity date, and coupon rate are evaluated at the time the bond is issued (Morris, McKay and Oates, 2009, p. 328). The shareholders assume all the risks and rewards from debt financing. As a result, debt financing can be relatively less expensive compared to equity finance depending on the expectation of the equity financiers. Equity Sources of Financing Companies usually seek capital from investors through the issuance of either common or preferred shares. Equity financing may also incorporate employee stock options. Equity funding does not incur interest or have to be repaid. Debt financing is usually more risky compared to equity financing, although equity financing is more expensive (Gleyberman, 2009, p. 8). Some of the advantages of debt financing include interest payments being tax deductible and that there is no dilution of ownership to the existing equity holders. The disadvantages of debt financing include the fact that the debt holder has priority over the company assets during liquidation. Besides, in cases where the investor doubts the capability of the company to meet interest payments, investors may demand higher interests to compensate for the uncertainty. In addition, there are several covenants associated with debt instruments that may constrain a company’s freedom of action (Albrecht, Stice, Stice and Swain, 2011, p. 507). In debt financing, loan repayment should be done on a predetermined date even if the business is in a loss. The cost to the company in debt financing is known beforehand. The cost to the company in debt financing is straightforward to predict, plan, and repay. Equity financing has several advantages such as no current payments due and no preferential rights on the company’s assets. The process of raising funds through equity financing is usually easy compared to through equity financing (Porter and Curtis, 2010, p. 526). However, the form of financing has disadvantages such as diluting ownership of current equity holders, which result in loss of control. Equity financing incorporates several security laws and parameters that the company is expected to abide by, which may not be applicable to debt financing. #2 Critical appraisals of the types of finance available for a UK listed company Every business needs a unique funding requirement depending on the circumstances. There are different types of finance reflecting the financing needs such as bank term loan, bank overdraft, asset-based finance, invoice discounting, leasing or hire purchase, issuance of bonds, and equity finance. Typically, a listed company in the UK will seek to obtain financing in one of the following three ways: issuing share (equity), issuing debt, or utilizing hybrid instrument such as convertible bonds (Bendrey, Hussey and West, 2004, p. 284). Debt Financing Debt financing may take a broad range of forms such as borrowing from banks and other institutional lenders. Debt financing by banks and other financing institutions may either be secured or unsecured. The form of security required hinges on several factors such as whether the loan is repayable on demand, in installments, or on a specified maturity date (Helbaek, Lindset and McLellan, 2010, p. 93). Issuing Bonds Bonds are a prominent form of debt financing. UK listed companies benefit significantly from issuing bonds since the interest rates that corporations are obliged to compensate the investors are relatively lower than the rates for most of the other forms of borrowing, as the interest paid on bonds is mainly a tax deductible expense. Equity Financing Equity financing refers to raising capital via the sale of a corporation’s shares and/or other securities. A company must comply with the applicable securities laws when issuing shares to avoid fines and penal sanctions. A company’s stock offering mainly falls into two categories: common and preferred stock. Common stock represents the basic equity ownership within a corporation. Common stock offers high potential in the long term in respect of dividend income and capital gains. Preferred stock is a form of equity bearing the characteristics of both bonds and common stock. Since it is not debt, preferred stock carries more risk than bonds (Kothari, 2006, p. 288). The dividends offered on preferred stock are usually offered on a fixed percentage basis on the par or face value. Hybrid Instrument Some financing vehicles encompass elements of both debt and equity financing. Investors may offer to lend money provided that the money is converted into equity upon satisfaction of certain defined events. A convertible loan provides the investor with security, while allowing for participation in the corporation’s growth via conversion to equity. #3 Evaluation of a UK listed company’s market value, over the last three years together with its finance needs Types of finance options available to Nautical Waves Plc Nautical Waves Plc has a diverse array of financing options from the perspective of direct financing and indirect financing: equity financing vs. debt financing. Nautical Waves Plc may fund its expansion through receiving credit from suppliers, obtaining lease financing, securing bank loans, issuing bonds, issuing additional stock, and factoring business debts (Ryan, 2004, p. 153). Internal source of financing incorporates funds generated from company’s operating activities such as retained earnings. Equity financing is another strategy that Nautical Waves Plc can utilize to obtain capital by issuing common and preferred stock. In the event that Nautical Waves Plc publicly floats stock in the LSE, equity investors become part owners of the company. Debt financing will require Nautical Waves Plc to acquire additional term loans and other forms of credit such as bank overdrafts (Sheeba, 2011, p. 291). Debt from a bank may be less expensive, although it may bear extensive covenants giving the lender certain remedies in the event that the covenants are unsatisfied. The company can also issue bonds on securities exchanges. The bond holders will expect Nautical Waves Plc to make interest payments annually or semi-annually, besides paying principal loan at maturity. Merits of Raising Debt versus Equity Debt financing bears a number of benefits over equity financing. These include lower cost of capital and fixed maturity date, and periodic interest payments, which means that the company can plan on the manner of financing the debt. In addition, debt funding amount is based on current cash flow. Similarly, since the lender does not make claim to equity in the business, debt does not dilute the ownership structure and has no effect on governance and control. Lenders do not have a direct claim to future profits of the company. Debt capital is less complicated since the company is not required to comply with various securities laws and regulations. Interest on the debt is usually deducted from the company’s tax return, which lowers the actual cost of the loan. Taking on debt by issuing bonds is relatively cheaper compared to either a bank overdraft or a share issue (Damodaran, 2011, p. 329). Description of UK Company with Market Capitalization of ?2 billion Capital Shopping Centres Group PLC (CSC) is a leading developer, landowner and administrator of prominent UK regional shopping centres (Eckett, 2005, p. 159). The company’s market value has remained fairly constant over the last three years. Nevertheless, the company’s revenue has changed dramatically over the last three years from ?405 million in 2009, ?420 million in 2010, and ?516 million in 2011. The company’s present market capitalization is ?2,890.18 million, as compared to ?2,665.50 million in 2011, and ?2,863.76 million in 2010. The company’s shares issued are 865,194,000 with a share price averaging around 334.00p with a present annual price high of 354.20 and annual price low of 301.10. The company’s net debt was ?3,494.5 million as of June 30, 2012. The company’s debt/equity ratio is 279.24%. Capital Shopping Centres Group PLC has undertaken diverse ways of sourcing funds such as equity financing and debt financing. For instance, in 2010, the company entered into an agreement with Token House Holdings Limited in acquiring The Trafford Centre Group together with ?74.4 million in cash, in exchange for 167.3 million new ordinary shares in CSC (Consideration Shares) and an aggregate nominal amount of ?209.0 million. The company also issued convertible bonds with a weighted average debt maturity of 6.6 years. On November 2010, CSC announced plans to place 62.3 million new ordinary shares representing 9.9% of the Company’s existing shares. The company’s refinancing plan details continuing with a diversified funding structure that pursues an opportunistic access to the bank and bond markets (Buckle and Thompson, 2004, p. 183). The management of Nautical Waves Plc faces a fundamental choice should the company borrow additional funds or take in new equity capital. The two have also diverse impact on the company’s leverage and dilution (Barrow, 2004, p. 49). The director of Nautical Waves Plc should pursue debt financing rather than equity financing in sourcing funds for expansion. The company can utilize bonds since they are the least expensive financing alternative. This is informed by the current volatility within the market and fluctuations of the share prices, which make floatation of additional shares into the market fairly unpredictable. Nautical Waves Plc must choose funding that is of low cost and risk resistant. The company should be wary of the debt-equity ratio since the larger the ratio, the riskier the company is considered by lenders and investors. In making its decision, Nautical Waves PLC is required to evaluate the choices such as maturity of the borrowing (short-term or long-term), whether the debt carries fixed interest payments or floating rates, as well as the nature of security availed by the form of debt (secured or unsecured) and the mode of repayment. Debt financing can either be short-term or long-term whereby full repayment is due in a period of more than one year. Debt obligations are typically limited to settling the loan with interest, which entitles the holder to a contractual set of cash flows (Schneenman, 2010, p. 422). Conclusion Debt financing can be an easier option for Nautical Waves Plc to take compared to equity financing such as issuing convertible bonds. Debt financing is relatively inexpensive because of interest tax shield. The only limit emanates from the fact that the more debt that the company issues, the higher the risk as the company has to pay the investors. In instances in which the firm has a high ratio of equity to debt, the company should seek debt financing. Nevertheless, in instances in which the company has a high proportion of debt to equity, it is advisable to enhance the company’s ownership capital (equity investment) for sourcing additional financing (Megginson and Smart, 2008, p. 529). Thus, the company will not be “over-leveraged” as to compromise its own survival. Adding too much debt may increase the company’s future cost of borrowing money and enhances risk for the company. Figure 1: Difference between debt and equity Equity Higher risk/higher return Debt Lower risk/lower return Ownership Confers ownership to the investor, as well as decision making power Does not confer ownership to the holder Right to gain from capital appreciation (right to profit) Bestows right to profit from capital appreciation either on sale or flotation The capital value is fixed reflecting the level of the initial investment. Lenders have a right to principal loan and interest accrued on it Participation in management Allows direct participation in management through the right to vote during the company’s meetings Fails to allow any participation in management Right to income Holds the right to dividend payments if voted for by management and if the company bear sufficient reserves Debt holders receives guaranteed income of interest payments regardless of the company’s profitability Repaid Generally never repaid Always repaid (debt has to be repaid within the stipulated time) Taxation Dividend is paid after tax (not tax deductible) Interest is paid before tax (interest payments are tax deductible) Security Unsecured Generally secured by effecting a charge on assets Ranking in insolvency Ranks the last after all other claims have been settled if the company becomes insolvent Ranks high up the list of claims in the event that the company becomes insolvent Figure 2: Capital Shopping Centres Group Balance Sheet Date of Fiscal Year End 31/12/11 31/12/10 31/12/09 31/12/08 Property, Plant and Equipment - Net. ?m 5.10 5,055.10 6,184.50 7,075.70 Other Intangible Assets ?m 9.30 0.00 0.00 0.00 Inventories – Total ?m 7.50 25.50 24.20 33.30 Current Assets – Total ?m 0.00 0.00 0.00 0.00 Cash & Equivalents ?m 90.70 222.30 597.50 100.50 Receivables (Net) ?m 46.80 32.50 60.50 86.60 Total Assets ?m 7,399.90 5,927.20 7,048.30 7,530.90 Accounts Payable ?m 0.00 0.00 0.00 0.00 Short Term Debt & Current Portion of Long Term Debt ?m 65.40 46.00 148.50 95.20 Current Liabilities – Total ?m 0.00 0.00 0.00 0.00 Working Capital ?m 0.00 0.00 0.00 0.00 Long Term Debt ?m 3,546.10 2,751.50 3,746.80 4,203.10 Total Debt ?m 3,611.50 2,797.50 3,895.30 4,298.30 Deferred Taxes ?m 0.00 0.00 37.10 0.00 Minority Interest ?m 23.50 19.90 0.00 27.80 Common Stock ?m 430.20 346.30 311.30 182.60 Common Equity ?m 2,922.10 2,273.40 2,414.40 1,950.40 Preferred Stock ?m 0.00 0.00 0.00 0.00 Total Capital ?m 6,491.70 5,044.80 6,161.20 6,181.30 Shares in Issue m 853.51 685.77 621.54 386.44 Market Cap (Year End) ?m 2,665.50 2,863.76 3,200.93 1,743.67 References Albrecht, S., Stice, E., Stice, J. and Swain, M., 2011. 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