Sydney City School of Business Case Study #2 (20 marks) Since graduation from co
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Question
Sydney City School of Business Case Study #2 (20 marks) Since graduation from college, you have worked at Precision Manufacturing Pty Ltd, as a financial analyst. You have recently been promoted to the position of senior financial manager, with responsibilities that include capital budgeting decisions and the raising of long-term financing. Therefore, you decide to investigate the various alternatives for raising funds. Your goal is to make sure that the benefits received from undertaking long-term projects are greater than the costs of raising the long-term funds needed to finance those projects. With this goal in mind, you decide to answer the following questions: 1. What should managers consider when making the decision whether to finance internally or externally? (4marks) 2. What services does an investment banker offer to businesses that choose to raise funds in the capital market? (4 marks) 3. What are the benefits to the company'of going public? (2 marks) 4. What are the drawbacks to the corporation of going publie? (2 marks) 5. What returns can investors in the ordinary equity expect on the first day of trading if they commit to purchase shares through the IPO issue? What factors may affect the relative amount of these first-day returns? (2 marks) 6. Describe the following offers: (a) seasoned equity offer; (b) rights offer, and (e) private placement. In what circumstances would a company use each of these offerings to raise funds? (3 marks) 7. Discuss the implications of the various capital structure theories for optimal capital structure including Trade-off Theory and Pecking Order Theory. (3 marks)Explanation / Answer
1. As a financial manager , the first step is to identify different forms of financing a project. Raising debt or equity are external forms of financing whereas,use of cash and sale of assets are internal forms of financing. As a manger it is important to understand the cost of financing with respect to each of the methods.
Raising debt: Here, the company comes under obligation to pay interest to its investors which could be a good way of raising fund as the company can avail tax benefits. However, at times long term debt tends to accumulate and lead to high interest payments which could be a burden for the company. Whereas, short term loan though can be repaid early it might lead to high installlments. Therefore, it is essential to understand the cost of raising debt from both long term and short term perspective.
Equity: Though it might seem to be an attractive way of raising fund, company should be clear if they are willing to go for equity dilution as this might lead to change in management and shift in strategic focus. Also, since the cost of equity is higher than cost of debt it is very important to understand if raising fund is a good alternative to debt.
Internal financing : This could be achieved through the use of cash or sale of asset. As a manager it is important to understand that if cash is being used for a new project then after using the cash, will there be sufficient liquidity with the company. Also, identifying assets which has lower Return on Asset and is of lesser utlity to the company can be sold to raise funds which can provide better return.
2. Investment banks are institutions which helps a company to make decisions and provide various services to the corporations when raising fund through capital market.
Underwriting: It is a process through which investment banks assess the eligibility of the company to raise fund. Also, they work as a security underwriter, wherein they tend to mitigate the company's risk by taking some securities of the company at a premium. This helps the company in getting some fund straight away, which could be used for their project. The underwriters are then responsible for selling their part of securities.
Agent: They also act as an agent whose main role is to match companies with investors. There is a possibilty that the company is unable to raise fund through IPO in that case investment bank help them to connect through different types of investors acting as a intermediary. For this they charge a fee from the company and in return helps the institution to raise fund in capital market.
3. Benefit to the company on going public: The biggest advantage is raising a lot of fund through IPO which can be used to further their business in the form of infrastructure, expansion or R&D. It also helps them to get listed on exchanges which is good for the company's prestige and would give them an opportunity to increase their business.
Mergers and acquisition also becomes smoother if the company is listed as the cash flow to smaller companies becomes easier.
4. In addition to some pros of going public, the company also faces somes disadvantages. The whole process of going public is a tedious process and might take six to nine months. During the process, the management had to spend a lot of its time in assessing the IPO which could affect the other parts of the business. Moreover, once the equity is raised shareholder's now have the stake in the company and they could have a large impact on the company's business. It becomes difficult and at times could lead to a shift in the company's goal. Upfront cost to the company also increases in the form of financial services provided, underwriting and filing fees.
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