mac2602topic 4 - Sources and forms of funding.pdf - 83 TOPIC 4 Sources and forms of finance Study unit 10 Sources of finance FINANCIAL MANAGEMENT

mac2602topic 4 - Sources and forms of funding.pdf - 83...

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83 MAC2602 Russell Jude © Edge Business School TOPIC 4: Sources and forms of finance Study unit 10 - Sources of finance FINANCIAL MANAGEMENT Objective: Maximising long term sustainable wealth (Cost of financing < Return on investment) FINANCING DECISIONS Objective: Obtaining funds with the minimum effective cost INVESTMENT DECISIONS Objective: Investing in sustainable projects with maximum long term returns Sources of Financing Funds must be raised to support the operations and investment programmes Externally (Large amounts that are occationally required to get organisations tarted or to support investment in major projets. There are 2 methods: Debt or Equity financing) Debt or Equity can be raised on the financial markets Capital market (Long term) Equity market JSE facilitates trading in equity securities Ie. Listed ordinary and preference shares Bond market BESA facilitates trading in debt intruments with maturities of >1year Ie. Bonds and loans Money market (Short term) Banks and other financial institutions facilitates the trading Ie. Inter bank loans, inter company loans, bills of exchange, commercial paper Internally (Day-to day fuds used to support routine activities) This is done by retaining operating cash flows and reinvesting it in the organisation
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84 MAC2602 Russell Jude © Edge Business School Study unit 11 - Forms of finance Debt versus Equity DEBT EQUITY Cost of debt = interest Cost of equity = dividends Interest is tax deductible Dividends are not tax deductible Cost of debt is lower than the cost of equity, due to lower risk to the lender Risk is low because: Regular capital and interest repayments Debt providers have priority over shareholders in case of liquidation Cost of equity is higher, due to the higher risk the shareholders are taking Risk is high because: No capital repayments and dividends are not guaranteed Shareholders are last in line for repayment in case of liquidation Cost to obtain is low (no flotation cost) Issue cost is high due to flotation cost Capital repayment required, this will place pressure on liquidity No capital repayment required, this will not place pressure on liquidity Using debt will decrease the WACC and increase the ROE because of the leverage effect. Too much debt however, will increase the risk profile which will result in a higher WACC Using equity will increase the WACC, because the cost of equity is higher than the cost of debt. Using debt will increase the financial risk and the D:E ratio Using equity has no impact on financial risk and will decrease the D:E ratio No impact on shareholders control Could have an impact on shareholders control (depending on the type of equity used)
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85 MAC2602 Russell Jude © Edge Business School Equity Equity Share capital Ordinary shares: A security offered to investors that bestows ownership.
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