Question

The Government of Ghana in an attempt to stimulate the Ghanaian economy after the COVID 19 pandemic has set aside GH¢600 million as a stimulus package for businesses. These stimulus packages are to be in the form of soft loans for businesses. However, some believe that these loans must be extended to firms in industries that are worst hit by the pandemic. As the Finance Director of your company, you have been tasked to present a proposal to the Board of Directors of your company for consideration. Your proposal must address the following:

1. The negative impact of the COVID 19 pandemic on the operations of your firm, justifying why your firm needs such a stimulus package? Your arguments should be situated within the industry within which you operate.

2. With your understanding of lessons on capital structure, which other four (4) factors should your firm consider before choosing this source of debt finance?

3. Discuss four (4) risks that your company is likely to be exposed to if it goes ahead with this source of debt finance.

4. Explain how this decision will affect the return to the equity holders or shareholders of your company following the arguments of M&M proposition 2.

(Note: Your essay should not be more than 1500 words. Professional marks will be awarded for presentation)

Answer 1

(i) COVID -19 has affected each and every sector of the economy on a very large scale negatively.The major potential looser sectors which are affected are Tourism & leisure,Hospitality industry, Education,Real estate,Manufacturing etc and to help these business government is helping them by giving the soft loans so that they can improve their conditions.Considering ourselves in the hospitality industry some of the negative impact on the firms are as follows:

• Due to covid -19 their operations of business have stopped leading to losses in the business
• they have to remove their talented and trained staff so as to avoid the employee cost that they can't bear because of huge losses
• even after opreations will begin there will nothing like before as people will avoid going to these places beacuse it is risky
• besides the operational issues the reduecd traffic to the hotel will also have an obvious cascading effect on revenue from F&B,MICE and other areas.
• Now they will have to do work at low cost when the operatins will begin
• it is first time the hospitality industry have been hit so hard and even when lockdown lifts up the things will take long time to get normal.
• Travel and tourism has also been affected like never before.

So considering all these negative impact in the sector we operate i thing our firm should get the stimulus package which the government is giving to control the conditions and failure in business.

(ii) The factors to be keep in mind while choosing the debt as source of finance are as follows:

1. Control- If the firm does not wish to dilute the control than they should raise funds through debt because issuing equity will dilute the right and control.
2. Tax benefit-Another factor is the tax benefit which is available on the interest expense paid by the company,Therefore if firms wants to reduce their tax liability they should raise funds from debt.
3. Risk- If the risk over the firm is too high then should not go for debt as interest and amount is required to be paid in case of failure as well.
4. Form of organisation and legal status- Sole propreitorship and partnership can't raise funds from equity therefore they can only raise through debt,that means we should the legal status before deciding the source of finance.

(iii)Although it is beneficial to raise funds through debt but there are risk associated with it also,these risks are as follows:

1. Interest rate risk- This risk arises due to change in interest rate form time to time,if we raise money at particular rate and after that rate fall than their will be risk.
2. Credit Risk-This is the risk of the counter party default that is default by fund house or borrower that means they do not repay the amount.
3. Lack of liquidity-This risk due to lack of market to sell funds when we want to exit from the contract.
4. Concentrartion risk-It is a risk which arises when all the amount is betted on few companies by the fund house as default by any of these companies will wipe out a significant portion of the investment.