Question

Let us say you are a manager of a given Multinational Corporation and requested to solicit a fund of $300 Million for a new project.  Explain the source of fund you will be looking for? Tell us the step-by-step action you will make in getting this fund from the sources you identified.

Answer 1

Answer:-

There is a requirement of $ 300 million for a new project.

There are three ways that can be used to get the fund
1) Using internal equity or retained earnings
2) Raising debt
3) Issuing new equity

This is known as the pecking order theory and send signal to investors about the financial health of the company

1) Using retained earnings - This is the cheapest way to fund the project. The retained earnings is the cash left with the company after distributing dividends from the net income. This way of funding does not incur debt and hence there is no interest expense to be paid for the project funding.

2) Raising debt - This is generally the most favoured form for the funding of projects. The raising of debt can be by means of loans from banks or financial institutions. The debt raised to fund the loan decreases the cash flows as some part of earnings goes into interest payment. The funding can also be through Non convertible debentures, issuing commercial papers ( for companies that has good financial health), issuing bonds etc. The interest rate of debt in case of loans generally depends on the credit history of the company and other ratios like liquidity ratios, solvency ratios and leverage ratios.

3) Issuing new equity - This is the most expensive process. This is done by Initial public offer (IPO) or Follow on public offer ( FPO). The IPO is for company which is not listed in the stock markets and the FPO is for companies that already has presence in stock markets. This can be done by hiring Investment banks which helps through the process of setting the price band of shares in listing. The investment banks charge some 2-5 % of floatation charges for whole process. This is the most expensive process of raising debt and the stock after listing on stock exchanges starts trading. The cost of equity is generally higher than the cost of debt.