Managing Financial Principles

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Assignment 1 – Sources of Finance

1. What are the gearing implications of (i) equity and (ii) loan financing for the current and future shareholders?

Raven Construction PLC has Share Capital of £400,000 and total long-term debts of £800,000 giving it a debt to equity ratio of 2:1. Therefore, Raven Construction PLC is said to be Highly Geared as it currently has £2 of debt for every £1 of equity. This is calculated from the following equation:

Long-term DebtCurrent Equity =Gearing Ratio

i. Equity Financing – This is the process of raising capital through the sales of shares and refers to an ownership in Raven PLC. The purchase of shares is a simple way of introducing permanent capital into the company. The introduction of new shares will reduce the gearing ratio in Raven PLC and will give the company a greater amount of equity available to cover its long-term debts.

ii. Loan Financing – This is a process of raising capital through the borrowing of equity from a third party that does not benefit from ownership of the company. The third party will loan an amount of cash over an agreed period and require payments, with interest, to be repaid over the life of the loan. This will give Raven PLC even more debt than equity. An increase in the amount of long-term debt will increase the gearing ratio further

2. Make clear recommendations to the company on how to finance their expansion?

Raven Construction PLC now requires £1.2m for its current planned expansion. Raven may find it very difficult to borrow more money from the bank and will need to consider all options to generate the finance it requires. Finance can either be generated from internal and external sources. Internal sources include retained profit and potential sale of assets while external sources could either be short or long-term arrangements. Long-term options are share capital…...

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