Question

#business law##accounting#

Question 6: Corporate funding

Alta (NZ) Ltd (Alta) is the New Zealand subsidiary of a Danish company. Alta’s senior managers buy out the business from its Danish parent. The managers will retain a majority stake in Alta but will sell shares to Monica Reeves, a venture capitalist. They wish to reinvest the funds they receive from Monica back into Alta. They are prepared to assume risk but need a monthly return and want to rank above Monica on liquidation.

Monica would like a portion of her investment in debt-like finance. However, the high level of Alta’s debt to equity ratio means that the bank would not prepared to lend it any more if the financing is structured this way so an alternative must be found.

Recommend a form of business finance that would best suit the needs of:

a) Alta’s senior managers

b) Monica.

Give reasons for your choice.

Answer 1

Solution (A)

If there is a high debt equity ratio of Alta As given in this case then the organisation follow the aggressive growth strategy.If there is a high debt equity ration then the managers are disagree for taking more borrowing as it can also made the debt equity ratio more high. Bankers actually have to know that how to manage the debt equity ratio of the firm . Bankers know how to manage debt-equity ratio while providing a loan. They may put in covenants in loan documents, saying, that the borrowing organization cannot exceed a certain number. If there is high debt equity ratio in a company then it can increase the financial leverage on the firm. and when the debt equity ratio is low it puts the company at a risk of low payout ratio. A high debt equity ratio shows the financial distress in the firm. Investors expect 12% or higher returns on equity, and, 4% interest on business loans. The interest is tax deductible . Tech based firms investing in R&D have a debt-ratio ratio below 2; for stable publicly listed firms it is between 2 to 5. Anything above 5 is risky. For banks, and, financial institutions it may be between 10, and, 20.

Monica can invest having a part of the investment in debt, but, she must be ranked lower, and, this must not increase the firm's risk, for banks to not lend to Alta. Debt investment will be categorized as secured credit with a fixed charge, or, secured creditor with a floating charge.

Alta can invest as a secured creditor with a fixed charge. Monica may invest as a secured creditor with a floating charge or in equity in a manner that the firm gets the funds in debt or equity as the organization prefers. Monica will rank lower on liquidation