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Businesses need both long-term and short-term funds in order to finance their operations and expand franchises. By borrowing from the capital market, a company can expand its current business without unnecessarily depleting its funds; hence it makes borrowing very suitable to ongoing businesses. Essentially, the capital markets deal in bonds, stocks, derivatives, and other business investment matters, such as trading of securities. This paper explores various options available for financing both domestic and international franchise expansion for a company named Expansion Plc. Whether the management decides to issue shares, debentures, or use retained earnings to finance the proposed project, each option has its merits and demerits that must be taken into a thoughtful consideration. The capital market also presents different time-frames for the payment of these debts whether on long-term, medium-term, or short-term basis.
Key Words: equity, debt, capital market, loan
Business organizations need both long-term and short-term funds in order to support their business expansion. By borrowing from the capital market, a company can expand its current business without unnecessarily depleting its funds; hence, it makes borrowing very suitable to ongoing businesses. Capital markets deal in bonds, stocks, derivatives, and other business investment matters. The capital markets are important because they are a playground for trading of securities and usually include bond and stock markets. Governments and companies use these markets for raising funds for their various operations.
This paper reviews different sources of long-term capital available for Expansion Plc quoted in London stock exchange, both equity and debt financing, including variations on their basic types, characteristic, risk consideration, cost, return, disadvantages and advantages from the point of view of the investors and the company. The study will also look at the issues involved in seeking a balance between the different types of long-term, medium, and short-term finance including the gearing debate, practical considerations, Modigliani and Miller theories, and industry variations. Lastly, the discussion will look at the current thinking on the efficient market hypothesis.
Evaluation of Different Sources of Long Term Capital
To raise the needed capital for expansion, the company could issue new shares in the stock exchange. In case the company decides to issue ordinary shares on pro rata basis to the existing shareholders, it is beneficial in the sense that the company’s ownership is not affected in any way. It is important to maintain the support that the company has been enjoying from the shareholders who are the owners of the company. For example, if the management seeking to expand their capital base decides to issue new shares to new shareholders because the capital being raised is small relative to the old shares, the company’s ownership will be minimally affected (Kirkpatrick & Dahlquist, 2010). This is the best way for Expansion Plc to obtain long-term equity to finance its expansion projects.
Debentures with a floating interest rate present to a company a long-term debt strategy to expand its capital base and cater for the intended expansion. Debentures are a form of legal loan stock that the company acknowledges and whose interest rate is paid periodically as negotiated, including the final repayment of the loan capital. The debentures with a floating interest rate are favorable to both the lenders and the company because the rates can be manipulated by the issuer depending on the market rates. These debentures are advisable for the company considering the volatile interest rates in the market as a result of the global economic crisis that has especially hit the US and the larger European markets.
From the point of view of the company, debt capital will be more attractive because the charges on interest are usually reduced from the gross profit of the company, thereby lessening its tax burden. Also, the debentures are usually redeemable before the maximum period of their maturity. To the company, this offers a chance to pay back the loan and avoid prolonged debt payment period after the new outlets become functional and profitable enough to service the loan. Therefore, if the company makes sufficient money to pay back the loan, it can redeem it as soon as possible to cut down on interests accumulating on the loan by paying off the loan as early as possible.
The retained earnings within the company present a better source of investment rather than paying high dividends in raising new equity. There is no repayment of cash to shareholders or creditors because the source of the money is within the company, thereby making it a cheap source of the needed capital for expansion. The management also bears all the authority in using the funds without the presence of red-tape decisions that come with shareholder-controlled funds. Moreover, unlike new issuance of debentures and shares that involve a cost to the business, the use of retained earnings avoids such costs (Kirkpatrick & Dahlquist, 2010). The changes in business control associated with new issue of shares are also eliminated by the use of the retained earnings of the company to expand the company’s production.
Issues Involved In Seeking a Balance between the Different Types of
Long-, Medium- And Short-Term Finance
Capital investment decisions are important in making long-term decisions on investment projects. Short-term decisions basically deal with short-term balances of both current liabilities and assets. Therefore, the type of project that the company needs to undertake determines the appropriate capital needs in corporate finance. In the current economic crisis, the risks are too high for any manufacturer to result to medium and short-term business financing. This is because the corporate finance market is full of turmoil; hence, the interest rates are abnormally high. As for the long-term business capital, they are usually paid after even more than 20 years in business or more depending on the lending terms and conditions. They are thus not focused on the present economic behavior with the ability to readjust the rates according to market behavior. In general, therefore, the type of project and the market conditions will be the guide for any business to decide whether to result to short-term, medium or long term borrowing to finance its business operations (Gray, 2011).
However, using the Modigliani and Miller theorem wrongly justifies the almost unlimited leverage in finance to fund company operations. Due to such assumptions, uncertainty, complexity, and high business risks saw high leveraged banks and other investments crumble due to the high leverage rations during the 2008 global economic crisis. The present gearing debate in the UK markets point to both the extremes in the market. With the present historical records of interest rates, the company should take the opportunity to get short-term funds to fund its balance sheet when business resources are committed to the new project. By the time the market starts to stabilize and interest rates start going up in the market, the company can then pay back to reduce its debt levels (Gray, 2011).
Current Thinking on the Efficient Market Hypothesis
The current thinking as far as Efficient Market Hypothesis (EMH) is concerned is that the markets are adequately efficient. In the weak form of efficient market hypothesis, earlier performances and other historical information are already reflected in the stock market prices. The technical analysis of the stock market would therefore be of no relevance. The fundamental analysis presents the only adequate way of viewing the market performances. The semi-strong mode of efficient market hypothesis is more reliable because in analyzing the stock market, insider knowledge and fundamental analysis provides important investment information for investor and companies.
In understanding the stock exchange through the technical analysis, it is assumed that there exist non-random price patterns that can effectively be exploited when identified. Trading actions and price are primary and since all the information is reflected in the share price, fundamental analysis is irrelevant. Changes in sentiments, trends do predate and predict changes in the market trends (Kirkpatrick & Dahlquist, 2010). Emotional responses by the investors influence the movement of chart patterns; therefore, the analysis underscores the stock values.
In this type of analysis, the business is analyzed financially. Its competitive, management, and market advantages are analyzed. The business analysis focuses on historical and present data, but the focus is on making financial projections. Possible objectives may include; establishing company’s credit risk, improving business performance and projection, evaluation of business environment, and making of business decisions.
For companies such as Expansion Plc seeking funds for international franchise growth, the capital markets present different avenues of attaining the much-needed capital both in the form of equity and debt financing. Whether the management decides to issue shares, debentures, or result to its retained earnings to finance the proposed project, each presents its advantages and disadvantages. The capital market also presents different time-frames for the payment of these debts whether on long-term, medium-term, and short-term basis. The current thinking in the investment market mostly relies on technical analysis of the market and the fundamental analysis in understanding the movement of market share values.