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Chapter 17 SOURCES OF LONG-TERM FINANCE

Chapter 17 SOURCES OF LONG-TERM FINANCE.  Centre for Financial Management , Bangalore. OUTLINE Equity Capital Internal Accruals Preference Capital Term Loans Debentures Comparative Picture.  Centre for Financial Management , Bangalore. EQUITY CAPITAL

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Chapter 17 SOURCES OF LONG-TERM FINANCE

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  1. Chapter 17 SOURCES OF LONG-TERM FINANCE  Centre for Financial Management , Bangalore

  2. OUTLINE • Equity Capital • Internal Accruals • Preference Capital • Term Loans • Debentures • Comparative Picture  Centre for Financial Management , Bangalore

  3. EQUITY CAPITAL • Equity capital represents ownership capital as equity shareholders collectively own the company. They enjoy the rewards and bear the risks of ownership • • Authorised capital • • Issued capital • • Subscribed capital • • Paid-up capital • • Par value • • Issue price • • Book value • • Market value  Centre for Financial Management , Bangalore

  4. RIGHTS OF EQUITY SHAREHOLDERS • Right to Income • Right to Control • Pre-emptive Right • Right in Liquidation  Centre for Financial Management , Bangalore

  5. SHAREHOLDER VOTING • Majority Rule Voting • Proportionate Rule Voting  Centre for Financial Management , Bangalore

  6. PROPORTIONATE RULE VOTING Number of shares required to elect a certain number of directors Number of shares Number of directors outstanding desired to be elected = Total number of directors to be elected X + 1  Centre for Financial Management , Bangalore

  7. PROS AND CONS OF EQUITY CAPITAL • Pros • No compulsion to pay dividends • No maturity date • Enhances creditworthiness • Dividends are tax-exempt in the hands of investors • Cons • Dilution of control • High cost  Centre for Financial Management , Bangalore

  8. INTERNAL ACCRUALS • Internal accruals of a firm consist of depreciation amortisation, and retained earnings. • Pros • Readily available • No dilution of control Cons • Opportunity cost is high  Centre for Financial Management , Bangalore

  9. PREFERENCE CAPITAL Preference capital represents a hybrid form of financing. It partakes some characteristics of equity and some attributes of debt. EquityDebt • Dividend not an obligatory • Dividend rate is fixed payment • Dividend not a tax-deductible • No voting right payment  Centre for Financial Management , Bangalore

  10. PREFERENCE CAPITAL • Pros • No legal obligation to pay dividends • Enhances creditworthiness • No dilution of control • Cons • Costly source • Skipping preference dividends adversely affects image • Voting rights under certain conditions  Centre for Financial Management , Bangalore

  11. TERM LOANS Term loans, given by financial institutions and banks, represent a source of debt finance which is generally repayable in less than 10 years. They are employed to finance fixed assets and working capital margin  Centre for Financial Management , Bangalore

  12. FEATURES OF TERM LOANS Currency Financial institutions give rupee term loans as well as foreign currency term loans Security Term loans typically represent secured borrowing. Usually, assets which are financed with the term loan provide the prime security. Other assets serve as collateral security. Interest Financial institutions charge an interest rate that is related to the credit risk of proposal. Principal Repayment Generally, the principal amount is repayable in equal semi-annual or quarterly instalments over a period of 4-8 years after an initial grace period of 1 to 2 years. Restrictive Covenants To protect their interest financial institutions impose restrictive conditions on the borrower.  Centre for Financial Management , Bangalore

  13. FEATURES OF DEBENTURES • Trustee • Security • Interest Rate • Call and Put Feature • Convertibility  Centre for Financial Management , Bangalore

  14. PROS AND CONS OF DEBT FINANCING • Pros • Lower post-tax cost • No dilution of control • Disciplining effect • Cons • Fixed debt servicing burden • Raises the cost of equity • Imposes restrictions  Centre for Financial Management , Bangalore

  15. COMPARATIVE PICTURE  Centre for Financial Management , Bangalore

  16. SUMMING UP • Equity capital represents ownership capital • Internal accruals consist of depreciation, amortisation, • and retained earnings • Preference capital represents a hybrid form of financing • Term loans and debentures are the most important • sources of long-term debt finance • Cost, dilution of control, risk, and restraint on • managerial freedom are the key criteria used for • evaluating the various sources of long-term finance  Centre for Financial Management , Bangalore

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