Question

Case Study:

ABC Company is med-sized company whose credit-rating in the market is average (Single A, according to S&P rating). The company is willing to finance a project whose cost is around QR 100 million and to be repaid over the next 10 years (Fixed Payment Loan). As the company rating is average, it can borrow from the bank at the average cost of borrowing which ranges from 5% to 7.5% or it can sell 10-year bonds at par, face value of each is QR 10,000, annual coupon payment is 5.8%. If the bonds advertising cost and cost of other listing requirements is QR 1.25 million to be repaid at the end of the first year. For sure, the firm thinks of the alternative that is cheaper and feasible in the light of its financial creditworthiness.

Case Requirements

1. What are the available sources to raise for funds for a typical Qatari company? Can you categorize these sources in a logical way?
2. What are the advantages and the disadvantages of the main sources of funds for a typical Qatari Company that you raised in the previous answer?
3. Suppose the cost of borrowing from banks is 6% based on the creditworthy of the borrower, while from financial Markets is around 5.80% without listing and issuing cost. Which is better for the ABC company to borrow from banks or to sell bonds on the markets based on the cost of each source and in the light of the data provided above? Attach the Excel sheet that shows your detailed calculations and the steps of calculations.
4. Explain in detail the reason for taking your decision in Question 3? Furthermore, raise other factors, which might deter the decision from choosing the source of funds indicated in Question 3?)

Answer 1

1.The Sources Available to raise funds are:-

a.Take a loan of 100 million from bank which is to repaid in the next 10 years at an interest rate ranging between 5% and 7.5%.

b.Issue bonds With a face value of 10,000 at par and with a coupon rate of 5.8% which will mature in 10 years.

These Sources Can be categorized into the following:-

a.Bank Loan.

b. Issuing of Bonds.

2.Advantages of taking Bank loan are:-

1.The Entire Amount is Available to the Debtor Within a small amount of time as compared to other sources like bonds or shares which shall take a longer time to sell.

2.Bank loan is generally a cheaper source of finance than issuing of bonds or shares.

3.No Advertising or listing cost is required as in the case of shares or bonds.

Disadvantages:-

1.Interest is to be paid to banks annually irrespective of profit or not.

2 Collateral are generally required in case of bank loan and will be need for such a large amount of 100 million which may not be required in case of bonds or shares.

Advantages of bonds are:-

1. Collateral requirement is optional in hands of the debtor in case of issuing of bonds.

2.A large amount of people are involved so there more certainty of receiving Funds as it high a credit worthiness.Such a large sum 100 million may not be available at the bank or it may not be willing to give such a large loan.

3.

Bank loan Interest rate	6%.
Loan Amount	100 million.
Time Period	10 yrs
Amount to be repayed in Ten Years	179.08
Coupon Rate of bond	5.8%.
Loan Amount	100 million.
Time Period	10 yrs
Amount to be repayed in Ten Years	175.73
Advertising and listing cost	1.25
total cost to the company	176.98
Difference In amount between issuing of bond and taking bank loan	2.10

Hence Issuing of bond will be cheaper than taking bank loan

4.As Calculated earlier the Issuing of bonds will be cheaper for the company so i suggest them to issue bonds in the market instead of taking bank loan.

The Other Factors Which might deter the choice of source of funds in the hands of the debtor are:-

1.Issuing of bonds are more time consuming than taking bank loan.

2.Interest has to be paid irrespective of weather the company earns profit or not which is not the case if it chooses to issue shares.

3.There is a possibility that all the bonds may not sell and the company may have a shortage of funds whereas the bank will provide it funds as much as required quickly as the company has a high credit rating of A.