Question

Essentials of Finance (non-majors) - principles of managerial accounting

Complete a 3-4 paragraph overview briefly outlining the different methods of funding a business or project. Identify the cost and opportunity cost of each option and how each choice affects the financial performance of an organization.

Answer 1

1) Getting a bank loan : It is the most general method of funding a business project, the cost of funding the project in this type is payment of interest to the bank and loan disbursement costs at the time of loan approval. The opportunity cost will be ivestment of the interest paid to bank loan in our project with less costs. The financial performance of an organization when bank loan was taken for the funding of the project depends on the rate of interest we pays, if the loan is short term loan the financial performance gets well played in the industry.

2) Retained profits : Using of our retained profits is the other type of getting funds for the project. The cost of using the retained profits will be payment of taxes and dividends to shareholders, where as the opportunity cost of using our own retained profits for the new project will be the locked in investment fund which will get considerable rate of return if gets deposited in bank or if invested in mutual funds or in the equity funds of the market. The financial performance of the organization in this type of funding will be generally most smooth where no pressure of repayment cut of dates etc.

3)Issue of debentures : In this type of funding the project the company will get the funds by issuing of debenture bonds to the outsiders whom will be called as debenture holders for a fixed rate of interest on the debenture face value, the cost associated with this type of getting funds is that of payment of fixes coupon interest and issuing cost associated while issuing the bonds legally. The opportunity cost of issuing bons is that the intrest amount paying to the bond holders may get invested as for another project. In this type of funding the company shall perform perfectly to get pay the bond holders time to time.