Question

Companies that choose to venture out on capital projects can utilize current savings, equity, or debt as ways to raise the needed amounts. Each has benefits and limitations which change as economic and fiscal policy actions occur in the national and international realms. As a result, the company will want to have a solid understanding of these factors and be able to support its choice. Based on the current economic environment, which of the 3 options mentioned above would you recommend to a company financing a 2-year project? A 20-year project? Make sure that you address risk tolerance as a significant part of your response.

Answer 1

a company should normally have all the components of financing in the company but proportion of each depends on the current market economic and fiscal policy along with other factors like risk and return. debt equity both has its own pros and cons relating to risk return components

since a company needs financing for 2 years, public equity part should be completely scrapped off as it is a tedious and long task and dilutes ownership and control over the company. however private equity which are owners fund should be first preferred as it is more flexible in terms of dividend pay and less riskier. current savings should be invested as per the company's performance and internal rate of return and as per to interest of the board but this is absolutely risk free source of finance. debt financing is however, a credit to the company and is riskiest form of finance but for a 2 year project this should be favoured depending upon the market rate of return because of ease in procurement and to retain full control over the project.

though for a 20 year project, equity should form the large part of the procured funds as it is less risky and pattern of dividends is flexible and has no obligation to repay the amount. debt financing increases the periodic interest payment obligation and increases financial leverage over assets of the company but the positive side of debt financing is its interest is tax deductible in U.S. current savings should be avoided for long term project as it of little amount as compared to the big chunks of equity and debt.

therefore for short term project debt financing should be favoured more whereas for long term project quity financing is more favoured.