Answer 1)
Every entity has its hunger for the capital, however, the decision to raise through the appropriate source and in which proportion is not a one day job. Thus, the borrowing company should consider the advantages and disadvantages of each source of finance, i.e. Debt and Equity. Below provided is a brief summary of both the sources of finance:
Advantages of Equity Financing:
A) Expanded Capital Base:
Equity Financing offers the advantage of raising large amount of capital. The amount so raised can be used for Research and Development projects, capital budgeting expansions, working capital requirements. All these advantages are quintessential to Fuel Company’s growth.
b) No Repayment Obligation:
Unlike Debt, Equity Financing does not carry any obligation to repay investor’s funds. This proves advantageous to the entrepreneur to focus on development plans of the company.
Disadvantages of Equity Financing:
A) Dilution:
Raising funds through equity financing lead to dilution of ownership to the investors. Though, the founders of the company after selling their shares in public keeps majority interest with them, but they still have a risk of unfriendly takeover years later after they sell more stock. Also, dilution of ownership of the company leads to loss of control and autonomy.
Advantages of Debt Financing
a) Low Cost Funding:
Since debt funds are collateralized borrowings, these are available at low cost as compared to equity financing.
b) Tax Deductibility:
Interest paid on debt funds is tax deductible and hence lower the earnings after tax and thus tax liability of the company is reduced.
Disadvantages of Debt Financing
A) Risk of Bankruptcy:
Since debt funds are issued against collateral securities, any irregularity by the company to repay interest or principal obligations can ruin financial ratings and creditability of the entrepreneurs and can even close the doors for future financing. Moreover, since the collateral property is pledged with the lending institution, they can even sell off the property to recover their outstanding funds. Thus, it will be a double loss situation for the entrepreneur where he not only loses financial creditability, but also his assets pledged to the bank.
Final Advice:
Considering the advantage and disadvantages of each source of finance, we can conclude that none of them is the perfect source, and each carries some risk and limitation. Hence, it will be most appropriate for the entity to adjudge the rationale proportion of debt and equity in its capital structure.
Answer 2)
Selecting an investment banker is of great importance at the time of raising funds through IPO issue. Thus, the issuer must look the following traits in their investment bankers:
A) Experience:
Raising funds through public issue is not an easy job, and it takes years of invaluable experience to successfully close the deals and raise the required amount of money for the issuer. Hence, the experience of the investment banker, their networks, their past performances on IPO issue, etc. is definitely the first trait to look in the investment bankers.
B) Support Team:
Although an investment banker can do a lot on his own, however, in order to raise the required amount of fund for the issuer, a dynamic and professional support team is required to create a dynamic marketing program that ensures that the issue is subscribed to the required extent and value of the company is maximized. Thus, the support team of the investment banker which includes financial analyst, legal and pricing analyst is other important persons to be considered while selecting an investment banker.
c) Tenacity:
Raising funds from public issue is not a one night job and takes months of planning and execution. Thus, the investment banker being selected should understand your goals in a professional capacity and should have the tenacity to get the issue subscribed successfully.
Final Advice:
An experienced investment banker can be a great asset for an entity and thus, the essential attributes as Experience, Professional Support Team and Tenacity, should be considered while selecting an investment banker.
Answer 3)
The signature principle of finance literature is that higher the risk higher will be the return. Furthermore, empirical analysis of past data relating to common stock and corporate bonds has concreted the notion that stocks offer higher returns owing to their high risk nature. Below provided is the risk-return data for Small-Cap Stocks, Large Cap Stocks and Corporate Bonds
The above table indicates that since small cap stocks had the highest risk level(indicated by standard deviation) it offers highest rate of return to the investors, on the other hand, corporate bonds with lowest level of risk, offered least returns to the investors, thus, validating the inverse relationship between risk and returns:
Diversification:
An investor can reduce the risk levels in his asset class by following the portfolio diversification process. However, he should only select stocks that are less than perfectly correlated to each other because when an investor diversifies across assets that are not perfectly correlated; the portfolio risk is less than the weighted average of the risks of the individual securities in the portfolio. Important to note that there are two kinds of risk embedded in the stock, Unsystematic Risk+ Systematic risk and the risk that is eliminated by diversification is only unsystematic risk and what remains is systematic risk. Hence, by selecting the portfolio of stocks that are less than perfectly correlated, the investor can diversify the unsystematic risk and will be compensated for bearing the systematic risk.
Works Cited
Brown, K. (2011). Portfolio Risk and Return. In C. Institute, Portfolio Management (pp. 170-172). Boston: Custom.
