Response to Classmates
kingstonman41
Week5Discussion1ClassmatesResponse.docxWeek 5 - Discussion Forum
Guided Response: Respond to at least two of your fellow students’ or instructor posts in a substantive manner and provide information or concepts that they may not have considered. Each response should have a minimum of 100 words and be respectful of others’ opinions and beliefs that differ from your own. Support your position by using information from the week’s readings. You are encouraged to post your required replies earlier in the week to promote more meaningful and interactive discourse in this discussion forum.
There are three of my classmates with discussion that needs to be responded to. Their name is Lisa Schreiner , Jamie Choate , and Madison Dern
Lisa Schreiner
SundayJul 26 at 1:58pm
As the CFO advising the organization’s CEO on how to proceed with funding for upcoming strategic initiatives, it is imperative to review and weigh all the options, including the pros and the cons of each option. Two particular methods are debt financing and equity financing, where the most cost effective method would be practical. Debt financing consists of borrowing from a financial institution in the form of a loan or issuing bonds to obtain cash from investors, either requires interest payments to the lenders (Boyte-White, 2019). Considerations for taking on additional debt are the debt to equity ratio of the organization which will impact the interest rate and ability to secure a loan, and the future revenue to cover payments on the debt. Organizational assets should impact the decision of expansion through debt. Assets such as cash and cash equivalents are considered financial capital providing healthy ratios to secure debt for funding initiatives (Boyte-White, 2019).
In this economic environment, issuing common stock is the safest avenue for the company. Although interest rates are at an all-time low, revenue is low due to the pandemic, reducing cash flow to make necessary interest payments. Common and preferred stockholders have an equity claim in the organization. The pro is that if revenue is low, dividend payments are not made and the con is issuing equity shares to stockholders dilutes the ownership value (Boyte-White, 2019). Issuing bonds requires interest payments to lenders or inventors, indicating cash outflows exist even if cash inflows are low or negative.
Buying back outstanding bonds or shares of common stock is an option to reduce debt outstanding and decrease external ownership. If a business has the cash available, the current market conditions provide for significant opportunities. The pros to consider are strengthening the organization’s financial position with healthy ratios, purchasing the bonds and common stock at a discounted rate, and positioning the company to expand once economic recovery occurs (Boyte-White, 2019). The disadvantages are relinquishing precious cash and reflecting a company has no major investments or growth on the horizon (Boyte-White, 2019). The company is not required to pay its shareholders a dividend.
References
Boyte-White, C. (2019, September 29). Top Two Ways Corporations Raise Capital. https://www.investopedia.com/ask/answers/032515/what-are-different-ways-corporations-can-raise-capital.asp (Links to an external site.)
Boyte-White, C. (2019, October 14). When Does It Benefit a Company to Buy Back Outstanding Shares? https://www.investopedia.com/ask/answers/040815/what-situations-does-it-benefit-company-buy-back-outstanding-shares.asp
Jamie Choate
WednesdayJul 29 at 4pm
As a CFO of a medium sized company I am responsible with advising the CEO on strategic initiatives, including the options available and impacts each option brings both long term and short term. As a medium sized company we need to raise more capital. There are two options with raising capital; through debt or equity. With both of these options we must weigh the costs as well as the short-term and long-term business impacts to determine the best and most cost effective method for the company.
Debt financing is borrowing money through the issuance of bonds, bills, or notes (Chen, 2020). The pros of debt financing is that, unlike equity financing, it gives one complete control of the company, the interest, fees, and charges are tax deductible, and you do not have to share the business profits (Chen, 2020). The cons to debt financing is that interest payments are due at least annually creating a strain on your revenue. When considering debt financing, the company should keep in mind their time interest earned ratio to ensure that the funds are available to cover its interest payments (Block, Hirt, & Danielsen, 2019).
Equity financing is the process of raising capital funding through the sale of shares (Banton, 2020). As shares are sold, ownership in the company is sold. The benefits to equity financing is that it does not require an annual interest payment and can bring in more cash if needed (Cremades, 2018).
When determining which method of capital financing you should go with the company must determine the cost of capital. To do this they need to determine the minimum return that the company expects to gain trough the investment decisions and determine if that return is enough to cover the cost of the additional debt or equity (Chen, 2020). If the investment is not expected to bring in returns greater than the cost of capital then the capital structure should be reevaluated.
With current market conditions due to the pandemic, I feel that it would be in the companies best interest to issue common stock. This will allow them to raise money without adding more debt to the balance sheet. This is the least expensive option since they will not be required to make obligatory interest payments but instead can make discretionary dividend payments (Terzo, 2020). With revenue already down, adding additional interest payments could impact the company in a negative way financially. However the company will have to be mindful of the amount of shareholders they bring on, diluting the current shareholder’s ownership stake (Terzo, 2020). With interest rates currently low, the price per share will be lower requiring additional shares to be sold to accumulate the funding needed.
The company could also elect to use its capital to buy back some of its existing bonds or repurchase common stock. This may be done if the company feels that the shares are selling too low in the market to elevate prices. This would reduce the number of outstanding shares, increasing the ownership of current shareholders (Janssen, 2020). This would also make the financial ratios of the company better by decreasing assets and in turn increasing ROA and ROE. The goal of a company is to maximize returns to shareholders and a buyback would increase shareholder value. In today’s economy with the stock market where it is, I do not feel as if this would be a good move. We currently do not see an upswing in the economy on the horizon and with current conditions there could be a risk that the stock prices could fall further after the buyback (McClure, 2020). This would also lessen the amount of cash the company has on hand to use for emergencies or further needed investment in the company.
Companies are not obligated to pay dividends out to their shareholders, however they may choose to do so to incentivize investors to continue investing in their company (Investopedia, 2013).
References:
Banton, C. (2020, July 1). Equity Financing. Investopedia. Retrieved from https://www.investopedia.com/terms/e/equityfinancing.asp
Block, S. B., Hirt, G. A., & Danielsen, B. R. (2019). Foundations of financial management (17th ed.). Retrieved from https://www.vitalsource.com
Chen, J. (2020, March 9). Debt Financing. Investopedia. Retrieved from https://www.investopedia.com/terms/d/debtfinancing.asp
Cremades, A. (2018, August 19). Debt vs. Equity Financing Pros And Cons For Entrepreneurs. Forbes. Retrieved from https://www.forbes.com/sites/alejandrocremades/2018/08/19/debt-vs-equity-financinpros-and-cons-for-entrepreneurs/#217a0f4d6900
Investopedia. (2013, August 27). Don’t Take Dividends For Granted. Forbes. Retrieved from https://www.forbes.com/sites/investopedia/2013/08/27/dont-take-dividends-for-granted/#5730571f5801
Janssen, C. (2020, March 19). Stock Buybacks: A Breakdown. Investopedia. Retrieved from https://www.investopedia.com/articles/02/041702.asp#what-is-a-stock-buyback
McClure, B. (2020, March 20). 6 Bad Scenarios for Stock Buybacks. Investopedia. Retrieved from https://www.investopedia.com/articles/stocks/10/share-buybacks.asp
Terzo, G. (2020). Pros & Cons of Issuing Common Stock. Chron. Retrieved from https://smallbusiness.chron.com/pros-cons-issuing-common-stock-55949.html
Madison Dern
WednesdayJul 29 at 8:16pm
Companies are often looking for ways that they can raise capital. This capital is used to either sustain business, build business, or cover unforeseen disturbances. That is something that all companies have in common. In order to raise capital, all companies must do it through debt or equity. Even the most successful companies must make critical decisions on how they finance their business decisions. You must think critically about where the investments are being made by company leadership. As a CFO, it is important to be the captain of the financial ship. You must make critical decisions on where to steer and which gears to pull when. As evidenced by past company successes and failure, it is definitely an art not a science.
Without seeing a balance sheet, it is impossible to have a right answer to the question of do you finance through debt or equity. If I were the CFO, I would need some details to determine what the correct next move is. Without having much additional information, debt can be an overall cheaper option. One of the main contributing factors to that is that once you have paid back the loan, you no longer have that liability. If you issue stock, it can be very expensive to buy back stock depending on the economic situation. On the opposite side, with debt, it can be easier to pay off the loan and only take out as much as you need. Another benefit that we have learned about in this course is that there can be huge tax benefit implications.
On the other side, you could issue stock to help raise capital. The positives of this mode of financing is that it can bring in a lot of money, especially when helping supplement financing solely sourced from debt. The downside to financing through equity is that you do not have much control over the medium. Although company actions can have a huge impact on the stock price, there are many factors outside of a company’s control. It is also likely that the liability will be dragged out longer than debt. You also do not have the tax benefits that are provided by financing through debt. Bonds are very similar to debt, but instead of a bank, you are borrowing money from investors. The great news is that these can be recalled by the issuer and may be so depending on interest rates. Common stock is not an ideal situation for companies because you have to relinquish more power since common stock holders have voting rights. Neither bonds or preferred stock are allowed voting rights which could be a positive for the company. Potential investors may be turned away from company issued bonds because they are more risky than government issued bonds.
In this current situation, if companies have extra capital it would be a great time for many companies to utilize this time in the economy to buy back stock. This can help reduce their equity to capital ratio. It is important to note that companies who have lower than average stock prices, probably do not have much disposable income to buy back their stock when the stock price is low. During that time, they are probably looking for anyways to save cash and support operations. Although you are not technically obligated to payout dividends, it is expected from investors and this is something that serious investors take seriously when considering where to invest their money.
Overall, I would make sure that the CEO understands the risks and negatives to the forms of financing. It will need to be determined how long it will take before the
