External Financing Essay Assignment Example | Topics and Well Written Essays - 1250 words

External Financing Essay - Assignment Example Several factors such as weighted average cost of capital (WACC) and agency costs should be considered in choosing an external funding source. The weighted average cost of capital is the minimum rate that a company is supposed to earn from the existing asset base in order to satisfy the owners, creditors and other capital providers. Agency costs restrict the leverage of a firm. Taking financial risks leads to higher leverage. This also increases the agency cost of debt and leads to lower debt capacity. Leverage helps to reduce the loss in terms of firm value. Therefore debt becomes advantageous especially in firms that have few opportunities of growth or high percentage of assets in place (Trigeorgis, 1995).This report explores the advantages and disadvantages of some of the major external financing options that Acme can employ. Equity The company can raise funds through issuing shares. They can either be common or preferred shares. Owners of common stock are partial owners of the com pany. They have the right to share company profits or dividends and vote at the company’s general meetings. Dividends paid to shareholders vary depending on the profits that the company is making. They also have preemptive rights to maintain the ownership of the company when gives another stock offering. However, common stock shareholders are the last to receive dividends after all the preferred stock shareholders. Owners of preferred stock also own the company partially but do not have any voting rights. Preferred stock pays fixed dividends. Preferred stock shareholders are the first to receive dividends and incase the company goes bankrupt, they will be paid before the common stock shareholders. Stock shares are advantageous because they are a permanent source of funding for the company and share capital cannot be redeemed. The disadvantage of this external financing method is that the ownership of the company is shared with the shareholders and they might make decisions th at might negatively affect the progress of the company (Davidson, 2002). Hire purchase Acme can also get external funding through hire purchase. The organization can acquire assets without investing the full amount in buying them. This agreement allows the company to use an asset for a certain period of time before it can fully purchase them. The firm is able to acquire an asset quickly without paying the full price and after the specified period of time, the company can either return it or purchase it a reduced price. This method is advantageous since the company can pay for the equipment through manageable installments from funds generated by the equipment. The disadvantage is that the total amount of installments exceeds the original cost of the equipment (Giovanelli, 1998). Bonds The company can also get external funding through issuing of bonds. The company offers loans in the form of debt securities. This method does not require companies to give up partial ownership of the co mpany. Bonds have either fixed interest rates or floating rates. More leveraged companies obtain more funding through bonds relative to stocks. This external funding method has several advantages. Issuing bonds is a cheaper method than bank overdrafts or equities since the interest from the debt is tax-deductable while equity dividends are paid out of taxed company’s profits. This strategy also helps companies to monitor their financial stability.