Question

In Chapter 10, we learned about the capital budgeting process and how firms measure the value of investment opportunities. In this chapter, we learn about short-term financing measures. When firms are capital budgeting, do they also consider these short-term loans and marketable securities?

Answer 1

Marketable securities are those which can be easily liquidated and are maintained for a period less than one year. The investment is made in these securities for two fold - main reason is they are completely liquid in nature and can be divested immediately, second - to earn treasury income at what lo west best one can earn.

Marketable securities include Stocks, Bonds, Mutual Funds. Money market instruments, futures, options, and hedge fund investments can also be considered marketable securities. However, the ultimate objective while investing in these securities should be of Liquidity.

Short term loan generally include, the Vendor channel financing, Working Capital Demand Loan, Commercia Papers, etc;

Short term requirements generally include the operational working capital funding, small capital investments etc

Long term requirements include major capex investments, long term strategic aspects like business expansion plans, business acquisitions, etc

Incase of the companies, which are going for major strategic expenditures, or major CAPEX investments, or any significant Capacity expansion or Market expanstion plans, they tend to go for the Long Term Funding; In the Short term funding, the servicing of the debt shall be very short term and these major capital projects shall need certain amount of time to generate cash flows. This results in the liquidity mismatch.

Hence, it is very unlikely that the companies choose short term or money market instuments for fund sourcing. They mostly prefer the Long term borrowings - either Long term debt or Equity or Bonds.