Sources Of Long term finance

Question 1

2 types of long term finance:

Answer 1

Debt
Equity
Existing cash resources
Grants

Question 2

What is long term finance used for:

Answer 2

To invest in assets with long, useful economic lives.

Question 3

What is Working Capital:

Answer 3

The cash available for day to day operations for an organisation:

Net Current Assets:
So
Current Assets minus current liabilities.

Question 4

What is Working Capital:

Answer 4

The cash (liquidity) available for day to day operations for an organisation:
To meet Short Term operating costs and debt obligations:
=
Net Current Assets:
So
Current Assets minus current liabilities.

Question 5

What is the yield of debt:

Answer 5

This is the interest rate

Question 6

Debt can be Deferred:

Answer 6

When the principal payments are delayed to a later date.

Question 7

Debt can be Rolled Up:

Answer 7

When interest is not paid, but still accrues on debt.

Question 8

What is Gearing:

Answer 8

It measures the proportion of debt finance in relation to either total finance or equity finance.

If Gearing is high there is more risk the company won’t be able to pay its debts.

Question 9

What level of Gearing is considered too high:

Answer 9

This differs from industry to industry, but typically over 50% is considered too high.

Question 10

Debt is considered a cheaper debt option than equity, because:

Answer 10

• debt must be paid back within a certain term.
• interest payments are tax deductible

Question 11

Equity available to:

Answer 11

• For profit organisations
• Not For Profit don’t have shareholders

Question 12

Equity available to:

Answer 12

• For profit organisations
• Not For Profit don’t have shareholders

Question 13

How long do equity investors tend to invest in a business:

Answer 13

Often no longer than 5 years.
They then want to realise their investment.

Question 14

What is the most expensive way to raise equity:

Answer 14

• Listing company on stock exchange,
  Due to the fees associated with listing the business and additional costs for listed companies.

Question 15

About Bonds:

Answer 15

• they are loans
• they have a Face Value (Par Value), Maturity and Coupon Rate.

Question 16

What is the Par Value of a Bond:

Answer 16

It’s the value that gets paid when the Bond matures.

Question 17

Formula for gearing ratio (debt to equity ratio):

Answer 17

Total debt / total equity

Question 18

Factors that affect what finance is sought and what is offered:

Answer 18

• Current financial structure, including Gearing
• Risk appetite of the entity and its shareholders
• industry and sector
• age and size of the organisation
• other forms of finance already raised
• trading performance (historic and forecast)
• security available
• lenders perception of risk
• management team ability
• purpose of the funds to be raised
• willingness of existing shareholders to reinvest
• willingness of new shareholders to invest
• credit rating

Question 19

Another name for Ordinary Shares:

Answer 19

Common stock

Question 20

Order in which creditors receive what is due to them, when a company gets wound up or liquidated:

Answer 20

1. Debt providers
2. Preference Shareholders
   Last: Ordinary shareholders

Question 21

Features of ordinary shares:

Answer 21

• higher return when the company does well:
• dividend could be higher than interest on a loan
• value of shares will go up
• Higher risk than debt:
• if the company doesnt do well, no dividend paid
• share value can go down
• ordinary shareholders are the last creditors to receive their investment back when a company is wound up.
• when additional equity finance is raised to new investors, this can lead to dilution of ownership.
• ordinary shareholders have voting rights:
• they can remove directors
• this gives them a certain level of power and control
• in some countries equity investment provides a tax break.

Question 22

Other names for the Nominal Value of an ordinary share:

Answer 22

• face value
• par value
• book value

Question 23

What is the Share Premium:

Answer 23

The excess of the amount over the Nominal Value, which makes the Market Value.
So the difference is called the Share Premium.

Market Value of a share is:
Nominal Value + Share Premium

Question 24

What items on the Balance Sheet are considered Equity:

Answer 24

• Share Capital
• Share Premium balance
• Retained Earnings
• Other Reserves

Equity is the total amount owed to the owner of the company in the event of liquidation.

Question 25

Risk around ordinary shares:

Answer 25

The risk is high from an investor point of view. But not from a business point of view. When issuing shares, a business is not committed to pay dividends. There is no obligation to repay the capital value to the investor. Some financial ratios may be positively affected when equity is issued. It can also be easier to issue shares or raise capital through equity. For debt you often need to provide a track record of success.

Question 26

Risk around ordinary shares:

Answer 26

The risk is high from an investor point of view. But not from a business point of view. When issuing shares, a business is not committed to pay dividends. It can also be easier to issue shares or raise capital through equity. For debt you often need to provide a track record of success.

Question 27

What is a rights issue:

Answer 27

When existing owners are asked to buy more shares.

Question 28

Disadvantages for the company to issue shares:

Answer 28

- the cost of debt is often cheaper, because interest payments for debt attract tax relief in most countries. - the admin costs around issuing of shares can be high, especially in case of an IPO.

Question 29

Characteristics of Preference Shares:

Answer 29

- Shareholder receives a fixed dividend each year over the nominal value. - However if there are no profits to pay this dividend, than no dividend is due.

Question 30

Redeemable versus Irredeemable:

Answer 30

Preference shares can be either: Irredeemable means that they do not have a maturity date, the same as ordinary shares. Or if they do have a maturity date, they are redeemable. The shareholders will receive their capital investment back at par or at a premium,, at a set date in the future

Question 31

Different types of Preference Shares:

Answer 31

- Cumulative preference shares - Noncumulative preference shares - Participating Preference Shares - Convertible Preference Shares

Question 32

What are cumulative preference shares:

Answer 32

In this case the dividend gets rolled over to the next accounting period, if the company can’t pay it. All preferential dividends need to be paid, before dividend can be paid to ordinary shareholders.

Question 33

Noncumulative preference shares:

Answer 33

The dividend does not roll over and is not due at a later date, if the company is unable to pay it.

Question 34

What are participating preference shares:

Answer 34

The shareholders received a fixed dividend plus an additional dividend if certain conditions are met, for example profit exceeding a certain figure.

Question 35

Convertible Preference shares

Answer 35

These shares can be converted into ordinary shares on a specific future date. The investor has the choice to redeem the shares for cash or convert them into ordinary shares. This is a very flexible option for an investor.

Question 36

Advantages and disadvantages of preference shares from a Company perspective:

Answer 36

Advantage: - dividends don’t need to be paid in the current accounting period, unlike interest. Disadvantages: - dividend must be paid, unlike dividend for ordinary shares. - it’s more expensive often than debt finance, because dividends are not tax-deductible, unlike interest.

Question 37

Advantages and disadvantages of preference shares from an Investor perspective:

Answer 37

Advantages: - Preferences shares provide usually a lower risk than ordinary shares, because they come with a fixed dividend. Other advantages depend on the type of preference shares. - Amounts due to preference shareholders are paid before amounts due to ordina shareholders Disadvantages: - the pay-out ranking is below debt financiers. So dividend may not be paid if the company can’t afford it. - In case of liquidation, preference shareholders rank below debt financiers in terms of receiving what is owed to them. - When considering the perspective of existing investors, the issuance of new preference share capital may be preferred, as it does not dilute ownership and control.

Question 38

Fixed and floating charge as security for debt finance:

Answer 38

Fixed is for example a building. Floating is for example inventory.

Question 39

What is a covenant placed on debt:

Answer 39

When the lender sets certain conditions. For example: - Restrictions on the level of dividends paid - Restrictions on additional debt that can be borrowed. - Limitations on what assets can be offered as security to other lenders. - Requirements to meet certain levels of profitability, cashflow and interest cover - in some cases, when covenants include financial ratios, these need to be reported quarterly to the lender.

Question 40

What is a covenant placed on debt:

Answer 40

When the lender sets certain conditions. For example: - Restrictions on the level of dividends paid - Restrictions on additional debt that can be borrowed. - Limitations on what assets can be offered as security to other lenders. - Requirements to meet certain levels of profitability, cashflow and interest cover - in some cases, when covenants include financial ratios, these need to be reported quarterly to the lender.

Question 41

Sources or providers of debt finance:

Answer 41

- Banks - Bonds - Private debt market - Venture debt - Debt and risk profile

Question 42

Types of loans offered by banks:

Answer 42

- Term loans with a fixed or floating rate. - Asset-based loans - Revolving credit facility (access to funds when needed, often with a variable interest rate) - Letters of credit (guarantee by a bank, that the company will make payment - often used in international trade) - Overdrafts - Trade finance products

Question 43

Other forms of debt finance:

Answer 43

- Banks loans - Bonds - Private debt market - Venture debt

Question 44

Venture debt:

Answer 44

- Is relatively expensive - tends to be reasons long-term - is often offered along-side equity fund-raising - used to raise funds for working capital and capital expenditure - is ranked before equity in the event of liquidation - Equitu warrants, options to buy equity at a later date, are often attached to the debt instrument

Question 45

Influence of debt on company risk profile:

Answer 45

- gearing increases when debt more debt is taken out - interest cover is affected by more debt

Question 46

What is an Offer for Sale:

Answer 46

It’s a type of IPO, but instead existing shares are offered to the public, to reduce the shareholdings of existing shareholders.

Question 47

What is a bonus issue:

Answer 47

If you offer additions shares to existing shareholders for free. Companies do this to reward existing shareholders when they are issuing new shares. To reduce dilution for shareholders.