Question

A firm needs to raise 150 million dollars for the project. What are the firm's options of raising funds to finance this large capital project.

Answer 1

The firm has 3 ways to finance this large capital project :

1) Debt

Firm can approach a bank and borrow funds for their project. Funds can be raised on the basis of the valuation and profitability of the project. Bank may solely fund the project or, since the amount is large, enter into consortium lending. In consortium lending system, two or more lenders join together to finance a single borrower. The lending banks formally join together, by way of an inter-se agreement to meet the credit needs of a borrower.

Firm can also approach an investment bank. Investment banks usually have wealthy clients who are willing to take risks. They will either lend the funds on it's own or help the firm to find lenders to invest in the firm's project for a small fee.

2) Equity

Firm can raise funds through issuing equity shares. These shares can either be issued to the general public or to instituional investors via private placement. Issuing shares are cost effective and they do not carry an interest burden. However, the voting rights come along with the equity shares, so the firm has choose between diluting ownership or suffering from interest burden.

3) Mixture of debt and equity

Firm can raise capital partly through debt and partly through equity shares. It can also issue convertible debt securities such as convertible bonds, which carry an option to be converted to equity at a specified date.

The choice of the above options depends on firm specific factors and on what the managers think is best for the firm. The firm has to evaluate which of the above options is most suited for them and would provide them the most benefit.