Cost of Financing and expansion at Radisson Plc
Analysing cost of financing the project using financial tool and recommendation of the choice [P 2.1]
Capital structure is defined as raising funds from different sources to create capitalization, various sources of funds include preference share capital, debt capital and equity capital. Capital structure of a company may be again referred as the relationship between debt capital and these long term funds (DeAngelo and Roll, 2015, P.390). Hence it becomes very important for a company to choose from these variants wisely in order to raise funds because it might affect the value of the firm if not managed properly.
According to the operation manager of Radisson Plc. lots of opportunities are available in the market to increase their market share in the industry.
In order to operate this operation the company has to analyse the cost of financing the project wisely. In one hand company has the option to raise funds either from the equity shareholders, preference shareholders, debenture holders or from the other long term credit and in the other hand the company must evaluate whether these decisions comply with company’s debt capital or not. To support the discussion a comprehensive summary is given below to show the comparison between equity finance and debt finance.
Before producing summary it is good to know the thesis regarding the procurement of funds and factors considered for procuring funds.
|Sources to procure funds|
|Loans and debentures|
|Risk to company|
|Cost to company|
|Dilution of existing control|
Let's assume the rate of interest and rate of dividend of :-
Loans and debentures = 10%
Preference share = 20%
Equity share = 40%
|Loans and debentures @10% (safest)||Preference share @ 20% (medium risk)||Equity @ 40%|
|1-Risk to company||Highest risk||Medium risk||Minimum risk|
|2-Cost to company||Minimum||Medium||Maximum|
|3-Dilution of of existing control (ownership right)||No dilution||No dilution||Full dilution|
Explanation of 1-Risk to company with respect to the source of funds.
Debenture interest is compulsory, so company faces maximum risk. If debenture interest is not paid the company will be considered as defaulter and shareholders may sue for winding up the company. Hence company faces highest risk.
Payment of preference dividend becomes compulsory only if the the company earns profit otherwise not. So, the firm faces medium risk.
However equity dividend is not compulsory even if the company earns profit, hence no risk to company.
Explanation of 2-Cost to company with respect to the source of funds.
Debenture holders are safest because payment of debenture interest is compulsory, hence they expect minimum rate of interest. Also tax benefit on interest will further reduce cost of debenture. So, cost to company is minimum.
Payment of preference only becomes compulsory if the company earns profit. so , preference shareholders expect medium rate of dividend. Also corporate dividend tax will increase cost of preference share. Hence preference share gives medium cost to company.
Whereas equity dividend is not compulsory, also they will be paid at last on liquidation. So, equity shareholders face maximum risk. Due to this reason they expect maximum rate of rate of equity dividend. However corporate dividend tax (CDT) increases cost of equity share. So, maximum cost to company can be expected.
Explanation of 3-Dilution of existing control.
Ownership right simply means whether new fund provider can interfere with the company's present decision making or not.
Debenture holders have no voting rights, hence no dilution.
Preference shareholders also have no voting rights, so no dilution, but if new funds are raised from equity shareholders, then the preference shareholders get the voting right (Renneboog and Szilagyi, 2015).
Equity shareholders have the voting rights, they will participate in decision making indicating full dilution.
Assessing the information of the financial decision making and financial planning [P 2.2, 2.3].
Financial decision making is a very critical part of the financial management of the company. In order to make the financial decision more reliable, financial information related to the financial statements need to be analysed retrospectively and prospectively. Apart from other peripherals of the management process, financial planning is the core element of the business management because financial statement reveals all the strengths and weakness of the company. Moreover in financial planning all the technical tools related to comparison of strength, mining the weakness can be used. For example preparation of common size and comparative size income statement and balance sheet. Thus it can be stated that information related to finance is more viable than other vital information (Tomlinson, 2015).
In the context of above explanation some importance of financial planning is listed accordingly.
- Assurance of sufficient funds
- Inflows and outflows of funds helps in maintaining stability of finance
- It also assists the firm to understand the market trend like stock marketing
Understanding the impact of selected financing option on financial statement [P 2.4, M2]
From the above discussion it is to be concluded that choosing right source of finance is not very easy because each source has advantages and disadvantages. Somewhere cost to company becomes high or somewhere risk to company rises. Hence it is better to raise funds form preference shares as it affects company moderately on overall aspects as it is shown in the above mentioned summary.