Overview of Corporate Financing Financial

Transcript:Overview of Corporate Financing Financial:
Overview of Corporate Financing Financial Economics: Corporate Finance Course: BA(H) Economics, Sem 6 For Hansraj College Patterns of Corporate financing Typical sources of funds/new investments for corporations comprise of the following: 1. Retained profits from business operations- used for reinvestment purposes 2. Sale of new Debt or Equity securities in the financial markets Given these key options for raising capital, certain important questions need to be answered in depth: Q1. How do firms actually make decisions about the patterns of funding in different business environments? Q2. What are the essential features of debt and equity? How are they different? Decisions that companies face: 1. How much of profit should be reinvested? 2. How much of the profit should be paid out as dividends? (Dividend policy needed) 3. What proportion of deficit should be financed by borrowing vs by issue of equity? (debt policy) A major portion of the money needed for business expenses (like the investment in long-term assets and net working capital), comes from internal sources like the money set aside by a company or retained earnings. In recent years, data has shown that companies often face a financial deficit ( gap between cash requirement of companies and that generated internally). Hence, companies need to either sell new equity or borrow cash from the market. Reliance on Internally generated funds: Funds set aside by firms as depreciation and retained earnings, comprising the internal funds, form a major proportion of the cash that firms need for investment. These sources of internal financing are seemingly more convenient for companies compared to external financing options like stock and debt issues. However, there is a worry that managers have an irrational or self-serving aversion to external finance. A manager seeking comfortable employment could be tempted to forego a risky but positive-NPV project if it involved launching a new stock issue and answering questions from potential investors. But there are also some good reasons for relying on internally generated funds. (1) The cost of issuing new securities is avoided, for example. (2) Moreover, the announcement of a new equity issue is usually bad news for investors, who worry that the decision signals lower future profits or higher risk. (3) If issues of shares are costly and send a bad-news signal to investors, companies may be justified in looking more carefully at those projects that would require a new stock issue. COMMON STOCK Companies mainly