Question

It is only July and we have run short of funds to pay our employees for the remainder of this year. As a result, we need to seek creative ways to help the company weather the storm... get through this problem. However, after conducting a series of brainstorming sessions, we are really no further ahead than we were before, so we have decided to hire an outside consulting firm, i.e. YOU, to help us decide upon the best option to pursue. Therefore, our options would be to pursue either debt or equity financing, or a combination of both and were we to pursue debt financing, we can engage in either short-term or long-term financing. If we pursue equity financing, we can sell either common or preferred stock, or bonds.   

1)         What are the advantages (pros) and disadvantages (cons) associated with DEBT financing, i.e. loan... debt?

            a) Long-term

            - Advantages... at least 2!

            - Disadvantages... at least 2!

            b) Short-term

            - Advantages... at least 2!

            - Disadvantages... at least 2!

2)        What are the advantages and disadvantages associated with EQUITY financing, i.e. stocks?

            a) Common stock

            - Advantages... at least 2!

            - Disadvantages... at least 2!

            b) Preferred stock

            - Advantages... at least 2!

            - Disadvantages... at least 2!

3)        Which course of action are you recommending, i.e. specific type of long-term or short-term financing, and what is your reasoning for recommending this type of approach? (Note: Your reasoning should be based upon and supported by the extensive research you had conducted… 25 points)

4)        What are some other… “alternative courses of action", other than those stated above, to obtain the needed funding discussed either in the text, or elsewhere?

  

Answer 1

Long term Debt Financing.

Advantages:

1. Debt is the least costly source of long-term financing.

2. It provides you flexibility in your capital structure.

Disadvantages:

1.  Debt usually has a fixed maturity date. Therefore, the financial officer must make provision for repayment of debt.

2.  Interest on debt is a permanent burden to the company. Company has to pay the interest to bondholders or creditors at fixed rate whether it earns a profit or not. It is legally liable to pay interest on the debt.

Short term Debt Financing.

Advantages

1. The company can enjoy tax saving on interest on the debt.

2. creditors have no interference in business operations because they are not entitled to vote.

Disadvantages:

1. Improper Risk management for Short Term debt can lead to strain in Liquidity of the firm.

2. The company must pay interest and principal at a specified time. Non-payment of interest and principal on time take the company into bankruptcy.

3. May contain restrictive covenants which may limit the company's operating flexibility in the future.

Common Stock:

Advantages:

1.  Equity shares do not create any obligation to pay a fixed rate of dividend.

2. Equity shares can be issued without creating any charge over the assets of the company.

Disadvantages:

1.  If only equity shares are issued, the company cannot take advantage of trading on equity.

2. Equity shareholders can put obstacles for management by manipulation and organizing themselves.

3. Costly source of finance.

Preference Stock

Advantages:

1. It is a permanent source of capital and the company has to repay it except under liquidation.

2. No Dilution in Control.

Disadvantages:

1. Preference in Claim (eg: during liquidation)

2. Skipping Dividend Spoils Market Reputation of the firm.

3: Solution

I would recommend Sourcing finance from Long term debt by issuing Callable Bond.

The firm appears to be in Liquidity crises and Long term Debt will provide me the flexibility to my working capital and Payment to my Employees and thus giving me time to increase my profitability and manage my financial risk.

Once the firm goes into a good situation as it is callable bonds, I recommend calling the Redeem it.

If the company believes it is a temporary situation and it is able to manage its Working capital and its a one-time event then its better to go with Working Capital Loan.  

4: Solution.

If the company is in a very bad Financial Crises and no one is willing to either give loan or Subscribe to its shares:

1. It's better to Sell the Assets of the company and repay the dues to employees. (OR)

2. Enter into Sale and Leaseback transaction and Repay employees with the procced.

(sale-and-leaseback, is a financial transaction in which one sells an asset and leases it back for the long term; therefore, one continues to be able to use the asset but no longer owns it.)  

Sale and Leaseback is the best solution when in deep crises and No one trust the firm. It must be the last resort (Its best)

Thank you and hope you find the answer helpful.