Question

List and describe ways managers can create firm value through financing alternatives. 175 words

Answer 1

Value of the levered firm is higher than the value of an unlevered firm. Hence the firm value can be increased by taking on more debt. This is due to the tax advantage received on the interest payments which are paid on debt undertaken. Due to the tax advantage, the cost of debt is lesser than the cost of equity and this results in lower weighted average cost of capital which increases the value of the organization. However taking on debt is accompanied with higher risk and hence the management needs to strike the right balance between debt and equity financing in such a way that the highest firm value can be achieved.

Basically, using the right financing alternative may create value depending upon the cost involved. Value is created when the profits or income is higher than the cost. Hence if, the management is able to select the right financing option with the lowest cost, it will be able to increase the value of the organization. Nowadays there are new financing alternatives available such as Mezzanine lending, private equity and crowdfunding which can be explored.