Good Report On Financing A US Listed Maritime Company

(Excel Maritime Company)
1 Introduction
According to Albertijn et al. (2011), the maximization of the shareholders’ wealth depends on the type of capital structure employed by the company. As defined by Ali, Salleh and Hassan, (2010), the capital structure is how an entity funds its operations and expansion using the various sources of funding available in the market. The capital structure of a company can comprise of equity, debt or a mix or both. The maritime companies listed on the New York Stock exchange can either be funded by equity, debt or a mixture of debt and equity based on the financial requirement of the individual firms (Albertijn et al. 2011). This report is aimed at discussing the various sources of funding that can be suitable for the Excel Maritime Carriers (EMC) Ltd. The EMC Ltd is a public limited company listed on the New York Stock Exchange operating in the shipping industry. The EMC Ltd was founded in the year 1988, and it is headquartered at Athens in Grease. The company serves the global market, and it specializes in the transportation of the bulk dry cargo. Examples of the bulk dry cargo transported by the company include coal, grains, and iron ore among others. The company projects to expand its operations, and it requires funding to achieve its projected growth. Therefore, this reported will be presented to the directors of EMC Ltd providing recommendations for the appropriate sources of funding that can help in maximizing the shareholders wealth. The report has five key section in which the first section introduces the report and the structure. The second section evaluates the available sources of funding such as equity and debt. The merits of raising debt versus equity are discussed in detail in the third section. The recommendations on the source of funding that maximize the shareholders wealth are provided in the fourth section. A comprehensive conclusion is provided in the last section.
2 Sources of Finance Available to Fund the Company
The company may seek to fund for various reasons such as the purchase of the new equipment, construction of a new building or the development of a new product. The EMC Ltd projects to expand its operations and it may seek funding from various sources such as equity, debt, retained earnings, venture capital or franchising. However, the type of funding required will have to match with the company's capital structure requirements (Altunbaş, Kara and Marqués-Ibáñez, 2010). The various sources of funding are evaluated in the following sections.
2.1 Equity
The equity source of funding can be in the form of ordinary shares, deferred ordinary shares, new shares, rights issue or preference shares.
2.1.1 Ordinary Shares
An entity may raise capital to fund its expansion through the issue of ordinary equity shares (Bougatef and Chichti, 2010). In most cases, the ordinary equity shares are issued to the company's owners and their face value is typically 50 cents or $1The nominal value and the market value of the quoted firm’s equity shares bear no relationship (Bougatef and Chichti, 2010). However, when the ordinary equity shares are given out for cash, the nominal value is equal or less than the market value of the issued shares.
2.1.2 Deferred Ordinary Shares
Unlike the ordinary equity shares, the deferred ordinary shares are entitled to dividends only when the profits attained reach a certain level (Carpentier and Suret, 2010). Additionally, the voting rights attached to this form of shares are different from those attached to the equity ordinary and other shares (Carpentier and Suret, 2010). There are two ways in which the shareholders can put money in their entity. Firstly, the shareholders may put money in the company through the purchase of the new shares. Secondly, the shareholders may put their money into the company through the use of retained earnings (Carpentier and Suret, 2010). For instance, instead, the company paying out the dividends, the shareholders may decide that the earnings be used in purchasing the issued deferred ordinary shares to fund the company. There are three circumstances under which the deferred ordinary shares can be issued (Covas and Haan, 2011). Firstly, the deferred ordinary shares can be issued when the company wants to raise money to fund its expansion. To maintain the control of the company, the rights issue are offered to the existing shareholders. Secondly, the deferred ordinary shares can be issued when the company partly wants to raise some cash and partly float its stock on the share exchange. Thirdly, the deferred ordinary shares might be issued to the shareholding of the other company for acquisition purposes.
2.1.3 Rights Issue
Through the rights issue, the existing shareholders are invited to raise new capital through the subscription of cash for the new shares proportionate to their current holding (De Mooij, 2012). When a firm decides to make a new rights issue, the share price is low so as get approval from the existing shareholders. However, the price should not be very low so as not to dilute the EPS.
3.1.4 Preference Shares
The preference shares contain a specified and fixed percentage of the dividends (Drobetz, et al. 2013). Therefore, before any ordinary shareholder is paid a dividend, all the preference shareholders must be paid. Raising funds through the preference shares has four key benefits. Firstly, the dividends are only paid to the shareholders the year the profit is realized, implying that no dividends are paid to preference shareholders if there is no profit. Secondly, the preference shareholders do not have the voting rights. Therefore, they cannot influence or dilute the ownership of the company. Thirdly, the preference shares are treated as debt, thus, they lower the firm’s gearing. Fourthly, the preference shareholders are not given the rights of appointing the receivers like the debenture holders.
2.2 Retained Earnings
The other alternative a maritime listed company can use to obtain funds for growth is through the retained earnings (Finnerty 2013). The firm can decide to reduce the amount of dividend paid out to the ordinary shareholders to re-invest the amount. There are two key benefits of using the retained earnings as a source of funding. Firstly, the retained earnings are not attached to any cost as compared to other sources of funding. Therefore, the retained earnings are not attached to issue costs that make funding from external sources expensive. Secondly, the retained earnings do not dilute the ownership of the company.
2.3 Debt/Loan Stock
Besides equity and retained earnings, a maritime listed company can fund its expansion through long-term debt (Egger et al. 2010). A company can prefer to borrow a loan stock from any financial institution to fund its projects. However, any loan capital requires the payment of interest besides the repayment of the principal amount. Additionally, the lending institution may require security assets to cover the secured loans (He and Xiong 2012). In cases of default, the lending institution is legally mandated to recover its loaned amount through the sale of loan security.
3 Merits of Raising Debt vs. Equity
As noted earlier, the capital structure of the company can either be made up of equity, debt or both depending on the company’s priorities. However, as noted by Kalamova, Kaminker and Johnstone (2011), the capital structure of the company should be aimed at maximizing the wealth of the shareholders. Raising funds through debt has some merits that may increase the wealth of shareholders as opposed to equity financing. There are five key merits why raising funds through debt is desirable in the capital structure as compared to equity. Firstly, debt financing can enable a company to undertake big projects such as the construction of the building and the purchase of capital intensive equipment required for the growth and expansion of a maritime listed company (Leary and Roberts 2010). Secondly, the lenders have no voting rights, and they cannot dilute the company ownership under whatever circumstances. The lenders have no right to infringe into the affairs of the company. Therefore, the lenders will not have access to the company’s confidential affairs such as profitability (Leary and Roberts 2010). Thirdly, debt lending enables a company to enjoy tax advantages since the interest on the loan is tax deductible. The tax savings reduces the cost of debt, and this can enable a company to make more profits. Fourthly, debt has simple obligations as long as the benefiting company complies with the laid down loan agreements (Margaritis and Psillaki 2010). The benefiting company only needs to ensure that it pays its principle amount and the interest and once the loan repayment is completed, the relationship between the lender and the company ends. Fifthly, the debt capital allows the company to predict and budget its progress precisely. Additionally, a company can decide to repay its loan amount within a short period to reduce the amount of interest charged. Besides these merits, Noulas and Genimakis (2011) argue that the debt financing has some limitations that a company must familiarize itself with before taking loan stock. The loan stock can negatively affect the company’s cash flow because it has fixed payment terms that must be followed strictly (Robb and Robinson 2012). Additionally, the higher rates of debt can damage the reputation of the company. In case the loan defaults, the company is likely to lose its assets to settle the loan (Schenone 2010). However, despite the mentioned limitations, debt is preferable than equity due to the following five reasons. Firstly, getting the right investors to willingly contribute funds to the company’s project is very difficult. Secondly, unlike debt, the investors will demand share ownership of the company, and they will be entitled to a certain percentage of profits. Therefore, the company ownership is likely to be diluted when raising funds through equity. Similarly, there is no single decision that can be made without consulting the equity shareholders (Ivashina and Kovner 2011). In the long, unlike debt, the amount repaid to the equity shareholders in the form of dividends is higher than the loan repayment.
4 Recommendation(s)
As argued by Tarca, Morris and Moy (2013), the optimal capital structure should ensure that the shareholders wealth is maximized at all costs. Therefore, the management of the EMC limited must weigh the merits and demerits of using both equity and debt to arrive at a decision that will lead to shareholders wealth maximization. For instance, the company should strive for achieving the best equity to debt ratio to maximize its value. More importantly, the EMC Ltd should ensure that it significantly reduces the cost of capital by ensuring that there is a balance between equity and debt. Overreliance on the debt will damage EMC's reputation, and this might scare away the potential investors. As postulated by Tarca, Morris and Moy (2013), an investor is keen on the gearing ratio of the company. Therefore, if the company's debt ratio is more than 50%, it scares away the investors. To avoid scaring away the investors, the EMC Ltd should combine both equity and debt to fund its projected growth. For instance, in the capital structure, EMC should ensure that the debt funding is less than 30%, and the rest can be either ordinary equity shares, retained earnings or the rights issue. Raising funds through debt, retained earnings and the rights issue will help the company to maintain its control. Additionally, as long as the debt ratio is below 50%, the company will remain attractive to both existing and the potential investors.
5.0 Conclusion
6.0 List of References
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