Chapter 5

Financing Feasibility Study

Sources of finance for business

1. Traditional Sources of FinanceA company’s assets, Invoice discounting, Personal savings Undistributed profits

2. Ownership capital :Ownership capital is the capital owned by the shareholders of a company. These funds are usually used for large expenses, such as new product development, expansion into a new market.

3. Non-ownership capital:Non-ownership capital includes funds raised from lenders, such as banks and creditors. Companies typically borrow a fixed amount from a bank, at a predetermined interest rate and with a fixed repayment schedule

Ownership capital1. Common stocks:Definition: Securities representing equity ownership in a corporation , providing voting

rights, and entitling the holder to a share of the company's success through dividends.

Common stock is ownership in a company, just the basic stock that we're used to trading. Companies sell common stock through public offerings, and it's traded among investors on the secondary market.

Those who hold the stock hope to earn dividends from their share of company profits.

Ownership capital2. Preferred Stock: Like common stock, preferred stock is sold by companies and is then traded among

investors on the secondary market.

Preferred stock is less risky than common stock, therefore investors can expect less reward, It's designed to provide an income generating opportunity for investors while raising capital for the underlying company

In many ways preferred stock works like bonds. While bonds guarantee regular interest payments, preferred stock guarantees regular dividend payments for a specified time.

Non-Ownership Capital

Non-ownership capital includes funds raised from lenders, such as banks and creditors.

Companies typically borrow a fixed amount from a bank, at a predetermined interest rate and with a fixed repayment schedule.

Certain bank accounts offer overdraft facilities. This is used by companies to meet their short-term fund requirements, as they usually come at a very high interest rate.

Source of Finance : Duration

Depending on the date of maturity, sources of finance can be clubbed into the following:

Long-term sources of finance Medium-term sources of finance Short-term sources of finance

Long-term sources of finance

Long-term financing can be raised from the following sources: Share capital or common share Preference shares Retained earnings Bonds of different types Loans from financial institutions Loans from commercial banks Venture capital funding International

Medium-term sources of finance

Medium-term financing can be raised from the following sources: Preference shares Bonds Public deposits/fixed deposits for duration of three years Commercial banks Financial institutions External commercial borrowings Foreign currency bonds

Short-term sources of finance

Short-term financing can be raised from the following sources:• Trade credit• Commercial banks• Fixed deposits for a period of 1 year or less• Advances received from customers

Common Stock BasicsCommon Stock Basics Dividends are payments made by a corporation to

its shareholder members. It is the portion of corporate profits paid out to stockholders.

Dividend Payout Ratio: The percentage of earnings paid to shareholders in dividends.

= dividends / net income

 

Common Stock BasicsCommon Stock Basics Capital Gain: Profit that results when the price of a security

held by a mutual fund rises above its purchase price and the security is sold (realized gain).

Income Stock: A stock that has a high, consistent, dividend paid annually.

Book Value: the value of the equity of the firm divided by the number of shares outstanding.

Market Value: is the price per share of the specified security multiplied by the number of shares outstanding for the specified security.

Advantages of Preferred Stocks

Collects the dividends per share before common shares It can be concerted into common share or to bonds Gets its value at the time of liquidations before common stocks

Disadvantages of Preferred Stocks

It has a higher cost than bonds Represents a fixed financial burden on the

project Their profits are not exempt from taxes Face the same risks faced by common

shares.

Factors Affect Stock Prices

Demand and supply of stocks Company Performance Investor Behavior Economic Growth Data The Foreign Institutional Investor Political Conditions

Types of Ownership

1. Sole Proprietorship – One Owner

Easy and inexpensive to form Few government regulations & reporting requirements No corporate income tax, only personal income tax

Advantages

! Hard to obtain large amounts of borrowing

! Unlimited liability (owner liable for total debt)

! Difficult to transfer ownership

Disadvantages

2. PARTNERSHIP

An agreement (verbal or written) between owners as to:! % of capital invested by each partner! How are profits shared?! How is it dissolved and/or ownership transferred?

Same advantages and disadvantages as a one owner Usually larger enterprise than sole proprietorship.

3. CORPORATION

Needs to be registered with a state as a legal entity, irrespective of who owns it. Owners receive shares in corporation Shareholders, who don’t necessarily know much about managing the company, elect board of directors Board

members are expected to oversee the “proper” running of the company. Board of directors appoints managers, generally different from owners, and is expected to ensure that

managers act in the best interest of shareholders.

3. CORPORATION

3. CORPORATION

Retain earning

• The percentage of net earnings not paid out as dividends, but retained by the company to be reinvested in its core business or to pay debt. It is recorded under shareholders' equity on the balance sheet.

But why does the company retain part of profit?

• In most cases, companies retain their earnings in order to invest them into areas where the company can create growth opportunities, such as buying new machinery or spending the money on more research and development.

Loan

• A loan is a debt provided by an entity (organization or individual) to another entity at an interest rate.

• In a loan, the borrower initially receives or borrows an amount of money, called the principal, from the lender, and is obligated to pay back or repay an equal amount of money to the lender at a later time.

• The loan is generally provided at a cost, referred to as interest on the debt, which provides an incentive for the lender to engage in the loan.

Bond

• A bond is a debt investment in which an investor loans money to an entity (typically corporate or governmental) which borrows the funds for a defined period of time at a variable or fixed interest rate. Bonds are used by companies, municipalities, states and sovereign governments to raise money and finance a variety of projects and activities. Owners of bonds are debtholders, or creditors, of the issuer.

Characteristics of Bonds

Most bonds share some common basic characteristics including:•Face value is the money amount the bond will be worth at its maturity, and is also the reference amount the bond issuer uses when calculating interest payments.•Coupon rate is the rate of interest the bond issuer will pay on the face value of the bond, expressed as a percentage.•Coupon dates are the dates on which the bond issuer will make interest payments. Typical intervals are annual or semi-annual coupon payments.•Maturity date is the date on which the bond will mature and the bond issuer will pay the bond holder the face value of the bond.•Bond Price : price of the bond fluctuates in the market in accordance with changes in interest rates

Rental finance

• The project can rent any equipment cannot be owned by the entrepreneur.

• The rent legal obligations and legal forms can be stated ad formalized in accordance to the contract between the two parties of the contract rented out and the rented