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 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

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

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

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

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

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

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

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

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

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

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

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

COMPARATIVE PICTURE  Centre for Financial Management, Bangalore

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