issuing equity shares

8/2/2019 Issuing Equity Shares

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Pros and cons of Equity shares and

Debentures

Profin manufactures Ltd. want to raise financefor the expansion of business but the following

conditions should not be violated

a) It should not lead to dilution of control

b) No mandatory payments of interest


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Issuing Equity sharesAdvantages

No legal obligation to pay dividend No fixed maturity

Provides cushion to lenders and increases thecredit worthiness of the company

A company can raise fixed capital by issuing equityshares without creating any charge on its fixedassets.

The capital raised by issuing equity shares is notrequired to be paid back during the life time ofthe company. It will be paid back only if thecompany is wound up.


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Disadvantages of Equity shares

Dilution of control (Two Systems of voting )

Majority and Proportionate Rule Voting

Cost of equity capital is high- most expensivesource of finance

Equity dividends are paid out of profits after

tax No trading on equity


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Debentures

Advantages

Increase in profits need not be shared

Funds raised without diluting control of equity share-holders

Interest payable is a charge on profit and hence reduces tax liability

Can adjust its debt-equity ratio

In case ofIrredeemable Debentures : These are also calledperpetual debentures. A company is not bound to repay theamount during its life time. If the issuing company fails to pay theinterest, it has to redeem such debentures.

Reliable source of long term finance : Since debentures areordinarily issued for a fixed period, the company can make the bestuse of the money. It helps long term planning.


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Disadvantages

Obligatory to pay interest at regular intervals

Necessity to make provision for repayment of

cost on maturity

Since it is long term it involves risk

Debenture-finance enables a company to

trade on equity.


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Suggestion- Source of finance

Zero Coupon Bonds/Deep Discount Bonds/Zerointerest(coupon) bond/Zero Bond

It does not carry any coupon rate but is issued ata steep discount over its face value(623)

For example, a bond with a face amount of20,000, maturing in 20 years, may be purchasedfor roughly 9,060, if the interest rate were 4%.The interest is compounded automatically untilthe bond matures

Zero coupon bonds-Face value and Inflationindexed

Long term and short term

Long term-Tax @ 10%


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Advantage

The biggest advantage of a zero coupon bond

is its predictability

Zero coupon bonds are available for varying

maturities

Dont have to pay regular interest

No dilution of control


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Disadvantage

Needs to pay huge amount on maturity


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Current situation Companies issue more zero-coupon bonds to lure FIIs

in last two months

For the current financial year, the investment limit forFIIs in non-infrastructure corporate bonds is $20 billion,or Rs 99,777 crore

According to data from the Clearing Corporation ofIndia, 43 per cent of the total primary issuances inJanuary were from the zero-coupon bonds category.

The maturities of these instruments ranged betweenone and five years.

In January, there was Rs 25,414 crore sales of zero

coupon bonds. Data from the equity markets regulator showed Rs

22,685 crore worth of the FII investment limit wasunused as on February 15


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Calculation

Let's look at how to calculate the price of a zero-

coupon bond that is maturing in five years, has a

par value of Rs.1,000 and a required yield of 6%.

Zero coupon bond price =m/(1+i)n

m=1000, i=6%/2=3,n=5*2=10

1000/(1+0.03)10

Rs.744.09


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Retained earnings

It is that portion of equity earnings which are

ploughed back in the firm

Company normally retain 30% - 80% of of

Profit after tax


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Advantage

Readily available internally

It effectively represent infusion of additional

equity in the form

No dilution of control


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Disadvantage

Insufficient amount

Opportunity cost is quite high

It is considered as sub- optimal investmentpolicy


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Rights issue

A rights issue provides a way of raising new share capital bymeans of an offer to existing shareholders, inviting them tosubscribe cash for new shares in proportion to their existingholdings.

For example, a rights issue on a one-for-four basis at Rs.280per share would mean that a company is inviting its existingshareholders to subscribe for one new share for every fourshares they hold, at a price of Rs.280 per new share.

A company making a rights issue must set a price which islow enough to secure the acceptance of shareholders, whoare being asked to provide extra funds


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Lines of Credit from Creditors

It refers to short term credit. By a 'line ofcredit' we mean that a creditor, such as a

supplier of raw materials, will allow us to buygoods now and pay for them later. Why do weinclude lines of credit as a source of finance?Well, if we manage our creditors carefully wecan use the line of credit they provide for us tofinance other parts of our business


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Credit cards

They're an easy and fast way to get and usemoney. But they're dependent on your personal(not business) credit-worthiness, affect your

personal credit score, may have high interestrates.

For e.g.- if a businessman can have 4 credit cardsand the limit per card is Rs. 2lakh then he can

used 8lakh for the given time.(Also one cantechnically used this amount for more days if hekeep track on the dates of payment )


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Take on a Partner

If there is someone interested in investing in yourbusiness, then taking on a partner could be agood way to finance your business expansion

Work with an attorney to develop a partnershipagreement, and use that agreement even if youare considering taking on a friend or familymember as a business partner

The agreement will outline the investment beingmade, the expected return and the role that thepartner will play in the business


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Friends and family

These are people who know you, believe in you, andwant to help you succeed.

They may offer loans or investments. But make surethat the financial relationship will not ruin the personal

one, especially if the business does not succeed. Be careful, also, when a family member or friend

makes you a "loan" that you don't have to pay anyinterest on. In the eyes of the taxman, that's a gift andmay be taxable

They(Businesses) Sometimes called us "friends, familyand fools, so be careful while parking your surplusfunds


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Sale of Assets

The business can finance new activities or pay-off debts byselling its assets such as property, fixtures & fittings,machinery, vehicles etc.

It is often used as a short term source of finance (e.g.selling a vehicle to pay debts) but could provide morelonger term finance if the assets being sold are veryvaluable (e.g. land or buildings)

If a business wants to use its assets, it may consider saleand lease-back where it may sell its assets and then rent orhire it from the business that now owns the assets. It maymean paying more money in the long run but it can providecash in the short term to avoid a crisis.


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References

Financial Management- Prasanna Chandra

Financial Management- Ravi Kishore

http://business-standard.com/india/news/companies-issue-more-zero-coupon-bonds-to-lure-fiis/466079/

http://www.fao.org/docrep/W4343E/w4343e08.htm#TopOfPage

http://www.bized.co.uk/learn/accounting/financial/sources/index.htm

http://www.usatoday.com/money/smallbusiness/columnist/abrams/2007-10-18-finance-sources_N.htm

http://www.entrepreneur.com/article/80204

http://www.nos.org/srsec319/319-19.pdf


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THANK YOU

issuing equity shares

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