Choosing an appropriate source of business finance can be a difficult and time-consuming task. This is due to the sheer amount of funding options available. Financing can come in the form of debt or investment, and finance terms can vary significantly. The criteria and implications of each source require critical analysis before proceeding, and it is essential to weight the cost versus benefits of each source before making a decision.
Required:
i) Discuss FOUR factors that a company should consider when choosing a source of debt finance. (6 marks)
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- Cost: both issue cost, interest rate and repayment terms.
- Maturity: This should be carefully matched with the cash flow structure and also flexibility of short term debt against long term debt.
- Financial risk: Debt increases gearing and hence financial risk of the company and how investors would view that.
- Availability of financing: This depends on size of borrowing relative to the size of the firm, relationship with bankers and other financiers.
ii) Explain THREE factors that may be considered by providers of finance in deciding how much to lend to a company. (3 marks)
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- Security: Are there available assets to be used to secure exposure? The size of debt or finance depends also on size of collateral available. Additionally, interest rate charge by lenders is a function of whether is a secured exposure or unsecured exposure.
- Risk and ability to meet financial obligations.
- Legal restrictions on borrowing.
- Management capacity and track record in the past and future expectation of their ability to perform and survive in challenging market environments.