Question

Litumezi Enterprise is a local private agro business run as a cooperative in Western Province of Zambia. The business was an initiative of the local Member of Parliament (MP) to encourage rice and cashew nut production, so that locals can tap into the economic benefit of the export markets in the region. Litumezi Enterprise is seeking to expand its operations as it has reached a critical stage in its life cycle. Since its initial Loan funding through Citizen Economic Empowerment Commission (CEEC) of K5, 000,000.00 the business has seen positive growth in the last 12 years and the Debt has since been settled. The business has put together an aggressive investment plan to expand the current project which includes increasing its current output of rice and cashew nuts to 3,000 hectares from 500 hectares as well as diversifying its operations to include Beef and dairy production. The Business plans on purchasing 500 herd of beef cattle and 100 dairy cows. Further there is a plan to add sugarcane production to its portfolio. All these investments will require huge investment in land, labor and equipment and logistics. Management has been advised by the Finance Manager that the business will need adequate and appropriate finance of about K20, 000,000.00 for both Asset acquisition and working capital. The project is expected to take 2-6 years before it breaks even and becomes profitable. Currently Management is debating on how to finance this project looking at the nature of operations and risks involved. Currently its net profit per year is K600, 000.00 while the K2, 000,000.00 of cash reserves in the bank fixed deposit account and has a finance lease for an equipment that will be fully paid off in the next 6 months freeing up K50, 000.00 of cash flow which is being paid each month. Purchasing the traditional land will cost K 8,000,000.00. Some of the local villagers however, are not happy giving up ancestral land and are demanding explanations on how this project will benefit them and their children. The K8, 000,000.00 will be used to purchase the livestock, trucks and equipment while the other K4, 000,000.00 is expected to be used as working capital. At this stage only preliminary studies have been done and many assumption have been used which could change. However, an investment appraisal was conducted and the project is viable even though management is still not very certain regarding climate and economic situation in the country and region. Required i. As a Corporate Finance expert discuss how the business could benefits from Financial Markets in the context of this project. (6 Marks) ii. What consideration should management take in choosing between long term Debt and Equity in financing this new project? (9 marks) iii. In your opinion how best can the above project be best financed. What would be the sources of finance and how much would you be looking to raise internally and externally. You are free to make relevant assumptions.

Answer 1

i) The business could help growth of the Financial market through export market by the development of agriculture and poultry within the region. Financial markets refer broadly to any marketplace where the trading of securities occurs, including the stock market, bond market, forex market, and derivatives market, among others. Financial markets are vital to the smooth operation of capitalist economies.

The expanded business can develop business in the following manner.

Puts savings into more productive use

A savings account that has money in it should not just let that money sit in the vault. Thus, financial markets like banks open it up to individuals and companies that need a home loan, student loan, or business loan.This in turn can serve the region in better ways.There happens a development of better financial services availability.

Lowers the cost of transactions

In financial markets, various types of information regarding securities can be acquired without the need.The cost of transactions act as a hinderance for many developments.

Export finance offers a way for businesses to release working capital , specifically from overseas transactions, that might otherwise remain tied up in invoices for long periods of time. It allows business to grow overseas resulting in more demand of production. It also increases the country's trade with large foreign multinationals.

ii ) Equity capital reflects ownership while debt capital reflects an obligation. Typically, the cost of equity exceeds the cost of debt. The risk to shareholders is greater than to lenders since payment on a debt is required by law regardless of a company's profit margins.

Debt vs Equity

S.No	Features	Debt	Equity
1	Meaning	Invest in loans	Invest in shares of company
2	Risk	Low risk	High risk
3	Return	Low	High
4	Return type	Interest	Dividend
5	Nature of Return	Fixed and Regular	Irregular(based on company's performance)
6	Volatility	Less	High

Here, it's better to raise debt capital since the capital requirement is for medium term. And it expected to have break-even after 2 to 6 years.

iii ) It is better the company raises fund internally itself because there has been sufficient cash reserve as bank deposit. The internal raising of fund make the business less riskier as there are no external obligation to pay up the debt.

Assuming the project can be started off within a short time waiting for the lease to be freed up. The company can find its own fund to start up the project.