Question

Evaluate the choices available to a private firm when deciding to raise additional capital

Answer 1

Additional capital can be raised by issuing equity stock, preferred stock, by raising short term or long term term loan as per the need, by issuing bonds and/or by reinvesting profits.

If the firm chooses to use its profits for reinvestment, it is the cheepest source of raising capital, but it also involves a cost i.e opportunity cost.

Funds can be raised by issuing equity stock, which involves paying dividend, but it is not a compulsory payment, because firm has to pay dividend only when there is profit available after payment of other liabilities. So it is a little cheeper source of finance.

Funds can be raised by issuing preferred stock, which involves fixed dividend payment, as payment of dividend is compulsory and not optional. So it is more costly than equity stock.

Funds can be raised by issuing bonds or by taking loans, but for short term as well as long term. If fund is raised for short term is is relatively more costlier than raising funds for long term because interest charged in short term is more than in long term. Also taking loan is costlier because it involves fixed interest liability, firm has to pay interest irrespective of profit or loss.

Thus the best way to raise additional funds is reinvesting profits if available.