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8/2/2019 Issuing Equity Shares
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Pros and cons of Equity shares and
Debentures
Profin manufactures Ltd. want to raise financefor the expansion of business but the following
conditions should not be violated
a) It should not lead to dilution of control
b) No mandatory payments of interest
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Issuing Equity sharesAdvantages
No legal obligation to pay dividend No fixed maturity
Provides cushion to lenders and increases thecredit worthiness of the company
A company can raise fixed capital by issuing equityshares without creating any charge on its fixedassets.
The capital raised by issuing equity shares is notrequired to be paid back during the life time ofthe company. It will be paid back only if thecompany is wound up.
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Disadvantages of Equity shares
Dilution of control (Two Systems of voting )
Majority and Proportionate Rule Voting
Cost of equity capital is high- most expensivesource of finance
Equity dividends are paid out of profits after
tax No trading on equity
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Debentures
Advantages
Increase in profits need not be shared
Funds raised without diluting control of equity share-holders
Interest payable is a charge on profit and hence reduces tax liability
Can adjust its debt-equity ratio
In case ofIrredeemable Debentures : These are also calledperpetual debentures. A company is not bound to repay theamount during its life time. If the issuing company fails to pay theinterest, it has to redeem such debentures.
Reliable source of long term finance : Since debentures areordinarily issued for a fixed period, the company can make the bestuse of the money. It helps long term planning.
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Disadvantages
Obligatory to pay interest at regular intervals
Necessity to make provision for repayment of
cost on maturity
Since it is long term it involves risk
Debenture-finance enables a company to
trade on equity.
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Suggestion- Source of finance
Zero Coupon Bonds/Deep Discount Bonds/Zerointerest(coupon) bond/Zero Bond
It does not carry any coupon rate but is issued ata steep discount over its face value(623)
For example, a bond with a face amount of20,000, maturing in 20 years, may be purchasedfor roughly 9,060, if the interest rate were 4%.The interest is compounded automatically untilthe bond matures
Zero coupon bonds-Face value and Inflationindexed
Long term and short term
Long term-Tax @ 10%
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Advantage
The biggest advantage of a zero coupon bond
is its predictability
Zero coupon bonds are available for varying
maturities
Dont have to pay regular interest
No dilution of control
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Disadvantage
Needs to pay huge amount on maturity
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Current situation Companies issue more zero-coupon bonds to lure FIIs
in last two months
For the current financial year, the investment limit forFIIs in non-infrastructure corporate bonds is $20 billion,or Rs 99,777 crore
According to data from the Clearing Corporation ofIndia, 43 per cent of the total primary issuances inJanuary were from the zero-coupon bonds category.
The maturities of these instruments ranged betweenone and five years.
In January, there was Rs 25,414 crore sales of zero
coupon bonds. Data from the equity markets regulator showed Rs
22,685 crore worth of the FII investment limit wasunused as on February 15
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Calculation
Let's look at how to calculate the price of a zero-
coupon bond that is maturing in five years, has a
par value of Rs.1,000 and a required yield of 6%.
Zero coupon bond price =m/(1+i)n
m=1000, i=6%/2=3,n=5*2=10
1000/(1+0.03)10
Rs.744.09
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Retained earnings
It is that portion of equity earnings which are
ploughed back in the firm
Company normally retain 30% - 80% of of
Profit after tax
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Advantage
Readily available internally
It effectively represent infusion of additional
equity in the form
No dilution of control
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Disadvantage
Insufficient amount
Opportunity cost is quite high
It is considered as sub- optimal investmentpolicy
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Rights issue
A rights issue provides a way of raising new share capital bymeans of an offer to existing shareholders, inviting them tosubscribe cash for new shares in proportion to their existingholdings.
For example, a rights issue on a one-for-four basis at Rs.280per share would mean that a company is inviting its existingshareholders to subscribe for one new share for every fourshares they hold, at a price of Rs.280 per new share.
A company making a rights issue must set a price which islow enough to secure the acceptance of shareholders, whoare being asked to provide extra funds
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Lines of Credit from Creditors
It refers to short term credit. By a 'line ofcredit' we mean that a creditor, such as a
supplier of raw materials, will allow us to buygoods now and pay for them later. Why do weinclude lines of credit as a source of finance?Well, if we manage our creditors carefully wecan use the line of credit they provide for us tofinance other parts of our business
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Credit cards
They're an easy and fast way to get and usemoney. But they're dependent on your personal(not business) credit-worthiness, affect your
personal credit score, may have high interestrates.
For e.g.- if a businessman can have 4 credit cardsand the limit per card is Rs. 2lakh then he can
used 8lakh for the given time.(Also one cantechnically used this amount for more days if hekeep track on the dates of payment )
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Take on a Partner
If there is someone interested in investing in yourbusiness, then taking on a partner could be agood way to finance your business expansion
Work with an attorney to develop a partnershipagreement, and use that agreement even if youare considering taking on a friend or familymember as a business partner
The agreement will outline the investment beingmade, the expected return and the role that thepartner will play in the business
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Friends and family
These are people who know you, believe in you, andwant to help you succeed.
They may offer loans or investments. But make surethat the financial relationship will not ruin the personal
one, especially if the business does not succeed. Be careful, also, when a family member or friend
makes you a "loan" that you don't have to pay anyinterest on. In the eyes of the taxman, that's a gift andmay be taxable
They(Businesses) Sometimes called us "friends, familyand fools, so be careful while parking your surplusfunds
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Sale of Assets
The business can finance new activities or pay-off debts byselling its assets such as property, fixtures & fittings,machinery, vehicles etc.
It is often used as a short term source of finance (e.g.selling a vehicle to pay debts) but could provide morelonger term finance if the assets being sold are veryvaluable (e.g. land or buildings)
If a business wants to use its assets, it may consider saleand lease-back where it may sell its assets and then rent orhire it from the business that now owns the assets. It maymean paying more money in the long run but it can providecash in the short term to avoid a crisis.
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References
Financial Management- Prasanna Chandra
Financial Management- Ravi Kishore
http://business-standard.com/india/news/companies-issue-more-zero-coupon-bonds-to-lure-fiis/466079/
http://www.fao.org/docrep/W4343E/w4343e08.htm#TopOfPage
http://www.bized.co.uk/learn/accounting/financial/sources/index.htm
http://www.usatoday.com/money/smallbusiness/columnist/abrams/2007-10-18-finance-sources_N.htm
http://www.entrepreneur.com/article/80204
http://www.nos.org/srsec319/319-19.pdf
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THANK YOU