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Financial Management Foundations - Essay Example
Author : davisdell
Pages 6 (1506 words)
In this paper, we compare five different financing alternatives available to investors in the financial market. Capital constrained investors can adapt either of these financing methods as each of them is dependent on the client's needs. However, some of these financing alternatives are common only to a few industries…
(Garcia-Terul and Martinez-Solano, 2000: p. 164). Investments in working capital constitute a tradeoff between risk and profitability because decisions that increase profitability also increase risk and vice versa. This is obvious even in capital markets where a tradeoff exists between risk and profitability. For example, investments in equities tend to be riskier than investments in savings accounts and bonds but equities tend to pay higher returns that savings accounts and bonds. (Bodie et al, 2005). A company that has a negative net working capital therefore faces higher risks than a company that has a positive net working capital irrespective of the profitability of the company. This is so because, the company with higher current liabilities may have high levels of debts that may be uncollectible, but which must have been included in the sales figure used in calculating profit. Debtors may default on the payment of debt and inventories may go obsolete. Finance literature has long recognized that market imperfection and information asymmetry affect finance. Thus, corporations must choose from the various financing options appropriate for them. These include, warrants issuance, derivatives instruments, common stocks and Preferred stocks etc. (Ambarish, John &Williams 1987). ...