Long Term Financing

LONG TERM FINANCE by Group – 1 Anish Aravind Charlie Jacob Jovita Nelson

NEED FOR LONG TERM FINANCE Increasing the facilities Expansion, diversification; huge quantities reqd., irreversible decision Buying fixed assets

SOURCES Equity capital Preference capital term loans Internal accruals Debentures Term loans

EQUITY CAPITAL Some terms Authorized, Issued, Subscribed and Paid up capital Par/face value, Issue Price, Book value and Market Value Rights of equity shareholders - Right to Income :PAT less preferred dividends - Right to Control : voting rights - Pre-emptive Right : for additional issues, rights issue in the same proportion - Right in liquidation : residual claim over assets

EQUITY CAPITAL Advantages No compulsion to pay dividends No fixed maturity, no obligation to redeem Dividends tax exempt for investors Disadvantages Dilution of control of existing owners High Cost: rate of return expected by equity holders higher than debt holders Dividends are not tax deductible: hence cost is higher Issue costs higher: underwriting, brokerage, other issue expenses

Advantages No obligation to pay dividend, no bankruptcy or legal action for non payment Financial distress of redemption obligation not very high Part of net worth, hence increases its creditworthiness/ leverage capacity No dilution of control No pledging of assets required

Disadvantages Expensive source since dividends not tax deductible Though no legal consequences, liability to pay dividends stands, can spoil company’s image Can acquire voting rights if company skips dividend for certain period Have claim prior to equity holders

INTERNAL ACCRUALS It consist of depreciation charges and retained earnings Advantages Readily available, no talking to outsiders Effectively additional equity capital, however no issue costs of loss due to under-pricing No dilution of control The stock market generally views an equity with skepticism, but retained earnings doesn’t

INTERNAL ACCRUALS disadvantages Quantum very limited High Opportunity costs: dividends forgone by equity holders Requires careful attention to NPV of projects

DEBENTURES Trustee: Need to appoint a trustee to ensure fulfillment of contractual obligations by company Security: Secured or unsecured Interest rate can be fixed/floating/deep discount More flexible compared to term loans as they offer variety of choices as regards maturity, interest rate, security, repayment and other special feature Convertibility Option : Can be with call or put feature Redemption: Bullet payment or redeemed in installment

TERM LOANS Provided by FIs/banks Repayable in less than 10 years Can be in domestic/foreign currency, liability on FC loans translated to rupees for payment Are typically secured against fixed assets/ hypothecation of movable properties, prime security / collateral security Definite obligations on interest and principal repayment; interest paid periodically; based on credit risk and pegged to a floor rate Carry restrictive covenants for future financial and operational decisions of the company, its management, future fund raising, projects, periodic reports called for

TERM LOANS Advantages Interest on debt is tax deductible Does not result in dilution of control Do not partake in value created by the firm Issue costs of debt is lower Interest cost is normally fixed, protection against high unexpected inflation Has a disciplining effect on management

TERM LOANS Disadvantages Entails fixed obligation for interest and principal, non payment can even lead to bankruptcy/ legal action Debt contracts impose restrictions on firm’s financial and operational flexibility If inflation rate dips, cost of debt higher than expected

RAISING LONG TERM FINANCE RAISING LONG TERM FINANCE Initial Public Offer (IPO) Secondary Public offer Rights Issue Bought out deals Euro Issues Private Placement Preferential allotment Venture Capital/ Private Equity transactions Obtaining a term loan

REFERENCE Prasanna Chandra – Fundamentals of Financial Management I M Pandey - Financial Management, 9 th edition Thank You

Long Term Financing

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