I.

APPROPRIATE SOURCES OF FINANCE FOR BUSINESS ESPANSION For business expansion, there are many options that help Xpresso raise capital. Business expansion would require the issue of more share capital or more loans or based on retained earning. 1. Retained earnings Like any companies, Xpresso retains their earnings in order to invest them into areas where the company can create growth opportunities. Using retained earnings to expand market is much safer than other choices. The company does not have to pay interest for others and get total benefits from their projects. They are also total independent to set the strategy or control their capital without pressure from others (interest, time banner). However, using own capital cannot bring much more benefits than borrowing. The company does not have much capital for other activities. Other thing is that using own capital, Xpresso does not have reducible the cost of debt capital so the net income will be influenced. Retained earnings = Net income Dividend Retained earnings are available to use and expansion is one of a part of business so it must be thought when Xpresso wants to expand their market. However, using all capital is not a good idea in business, the company has any other projects and they must use their capital to balance their business operation. 2. Issuing new ordinary shares To raise capital, Xpresso may issue new ordinary share in order to attract more investors, who are willing to become new shareholders of the company. Issuing new shares is suitable for raising large amount of cash because public ordinary shares of a growth company will attract more investor if they feel the project can bring much benefit for them. Moreover, this helps the company avoid the need to raise cash from existing shareholders. It also reduces the risk of a future takeover taking place.

On the other hand, existing holders may affect this option because it increases the number of shareholders in the company, so the dividend which the company pays for existing shareholders will be influenced and the control of them will be dilute. Besides, most ordinary shares are irredeemable, in that the capital cannot be repaid to the shareholder. It is also difficult in fixing an issue price, particularly in a volatile market like Vietnam. Xpresso Delight Limited need US$ 20 million dollar for the business expansion, but in business, the company will not use US$ 20 million dollar one time. Xpresso will divide the amount of money for five year. That means Xpresso will use US$ 4 million dollar for one year. For the option issuing new shares, Xpresso will pay flotation cost (17 %) and dividend in the first five year. From the sixth year, Xpresso just have to pay dividend for shareholders. The cost that the company must pay for each year will follow. Year 1: $ For 1 share, the company issue (Proceeds) The dividend the company pays for 1 share Dividend/1$ (Dividend/Proceeds) Flotation cost for 1 share Total cost for issuing ordinary share Dividend for existing shareholders Total cost Required fund Dividend Flotation cost Total cost 1.50 0.20 13.33% 17.00% 30.33% 0.00% 30.33% 20,000,000 13.33% x 20,000,000 17.00% x 20,000,000 %

2,666,667 3,400,000 6,066,667

Year 2 In year 2, Xpresso has two kinds of shareholders. One is shareholders, who bought ordinary shares in year 1 and another is new shareholders, who buy shares in year 2. The dividend in year 2 is not only $0.2/share, normally; it increases 0.2 x (1+15%).

For 1 share, the company issue (Proceeds) The dividend the company pays for 1 share Dividend/1$ (Dividend/Proceeds) Flotation cost for 1 share Total cost for issuing ordinary share Dividend for existing shareholders Total cost Required fund Dividend Flotation cost Total cost

0.2 x (1 + 15%)

$ 1.50 0.23

15.33% x 1

15.33% 17% 32.33% 15.33% 47.67%

20,000,000 15.33% x 2 x 20,000,000 17.00% x 20,000,000

6,133,333 3,400,000 9,533,333

From year 3 to year 5, the dividend follows the same formulae: A x (1+15%) with A is the number of dividend in the previous year. Year 3 For 1 share, the company issue (Proceeds) The dividend the company pays for 1 share Dividend/1$ (Dividend/Proceeds) Flotation cost for 1 share Total cost for issuing ordinary share Dividend for existing shareholders Total cost $ 1.50 0.26 %

0.23 x (1 + 15%)

17.63% x 2

17.63% 17% 34.63% 35.27% 69.90%

Required fund Dividend Flotation cost Total cost Year 4 For 1 share, the company issue (Proceeds) The dividend the company pays for 1 share Dividend/1$ (Dividend/Proceeds) Flotation cost for 1 share Total cost for issuing ordinary share 17.63% x 3 x 20,000,000 17.00% x 20,000,000

20,000,000 10,580,000 3,400,000 13,980,000 $ 1.50 0.30 %

0.26 x (1 + 15%)

20.28% 17% 37.28%

Dividend for existing shareholders Total cost

20.28% x 3

60.84% 98.11%

Required fund Dividend Flotation cost Total cost Year 5 For 1 share, the company issue (Proceeds) The dividend the company pays for 1 share Dividend/1$ (Dividend/Proceeds) Flotation cost for 1 share Total cost for issuing ordinary share Dividend for existing shareholders Total cost $ 1.50 0.35 20.28% x 4 x 20,000,000 17.00% x 20,000,000

20,000,000 16,222,667 3,400,000 19,622,667 %

0.30 x (1 + 15%)

23.32% x 4

23.32% 17% 40.32% 93.28% 133.60%

Required fund Dividend Flotation cost Total cost In the year 6, the company just pay dividend for shareholders. 23.32% x 5 x 20,000,000 17.00% x 20,000,000

20,000,000 23,320,083 3,400,000 26,720,083

Required fund Dividend Flotation cost Total cost

Year 1 20,000,000 2,666,667 3,400,000 6,066,667

Year 2 20,000,000 6,133,333 3,400,000 9,533,333

Year 3 20,000,000 10,580,000 3,400,000 13,980,000

Year 4 20,000,000 16,222,667 3,400,000 19,622,667

Year 5 20,000,000 23,320,083 3,400,000 26,720,083

3. Issuing preference shares

In order to raise capital but does not dilute the control of existing shareholders, Xpresso may issue preference shares for existing shareholders. The shareholders, who own reference shares, cannot effect the decisions of the company. However, the company must pay dividend for reference shares before ordinary shares. Sometimes, preference shares are issued in redeemable form. That means they will be repurchased by the company which issues them at a specified date. Thus, this may influence the plan of the company. For reference share, the dividend of them does not fluctuate year by year, it is fix at 9.52%/1$. The calculation of preference cost as below. Year 1 For 1 share, the company issue (Proceeds) The dividend the company pays for 1 share Dividend/1$ (Dividend/Proceeds) Flotation cost for 1 share Total cost for issuing ordinary share Dividend for existing shareholders Total cost Required fund Dividend Flotation cost Total cost Year 2 For 1 share, the company issue (Proceeds) The dividend the company pays for 1 share Dividend/1$ (Dividend/Proceeds) Flotation cost for 1 share Total cost for issuing ordinary share Dividend for existing shareholders Total cost Required fund Dividend Flotation cost 20,000,000 9.52% x 2 x 20,000,000 10.00% x 20,000,000 3,809,524 2,000,000 20,000,000 9.52% x 20,000,000 10.00% x 20,000,000 $ 42 4 9.52% 10.00% 19.52% 0.00% 19.52% %

1,904,762 2,000,000 3,904,762 $ 42 4 9.52% 10.00% 19.52% 9.52% 29.05% %

Total cost

5,809,524

Year 3 For 1 share, the company issue (Proceeds) The dividend the company pays for 1 share Dividend/1$ (Dividend/Proceeds) Flotation cost for 1 share Total cost for issuing ordinary share Dividend for existing shareholders Total cost Required fund Dividend Flotation cost Total cost

$ 42 4

9.52 x 2

9.52% 10.00% 19.52% 19.05% 38.57%

20,000,000 9.52% x 3 x 20,000,000 10.00% x 20,000,000

5,714,286 2,000,000 7,714,286

Year 4 For 1 share, the company issue (Proceeds) The dividend the company pays for 1 share Dividend/1$ (Dividend/Proceeds) Flotation cost for 1 share Total cost for issuing ordinary share Dividend for existing shareholders Total cost Required fund Dividend Flotation cost Total cost

$ 42 4

9.52 x 3

9.52% 10.00% 19.52% 28.57% 48.10%

20,000,000 9.52% x 3 x 20,000,000 10.00% x 20,000,000 7,619,048 2,000,000 9,619,048

Year 5 For 1 share, the company issue (Proceeds) The dividend the company pays for 1 share Dividend/1$ (Dividend/Proceeds)

$ 42 4

9.52%

Flotation cost for 1 share Total cost for issuing ordinary share Dividend for existing shareholders Total cost Required fund Dividend Flotation cost Total cost In year 6, Xpresso only pay dividend.

9.52 x 4

10.00% 19.52% 38.10% 57.62%

20,000,000 9.52% x 3 x 20,000,000 10.00% x 20,000,000 9,523,810 2,000,000 11,523,810

Required fund Dividend Flotation cost Total cost

4. Option 3:

Year 1 20,000,000 1,904,762 2,000,000 3,904,762

Borrowing

Year 2 20,000,000 3,809,524 2,000,000 5,809,524

Year 3 20,000,000 5,714,286 2,000,000 7,714,286

Year 4 20,000,000 7,619,048 2,000,000 9,619,048

Year 5 20,000,000 9,523,810 2,000,000 11,523,810

One of the optimum options for business expansion is borrowing from the banks. With the same project, borrowing money brings more profit than using own capital. Furthermore, Xpresso can use their capital for other business activities. The company can control its own destiny regarding business and own all the profit it makes. They can also reduce the cost of debt capital by the tax relief; this is one of the most important things that the company should consider carefully. Nevertheless, borrowing brings more risky if the company cannot earn profits or delay to pay interest for lender. This will broke the relationship with the bank and influence future borrowing. The image in the public is also influenced, nobody believes a company who cannot pay loan or delay too many times. Interest rate Tax relief (tax rate 25%) Debt 15% 75% 11.25%

1 - 25% 15% x 75%

In the next 4 year, the debt will increase 2, 3, 4 and 5 times. Therefore, we can calculate the amount of interest Xpresso must pay in five years for borrowing.

Debt Year 1 Year 2 Year 3 Year 4 Year 5 % 11.25% 22.50% 33.75% 45.00% 56.25% $ 2,250,000 4,500,000 6,750,000 9,000,000 11,250,000

11.25% x 2 11.25% x 3 11.25% x 4 11.25% x 5

The table shows the costs/$1 that Xpresso must pay each year if they borrow Year 1 Fund Debt 1.0000 0.1125 Year 2 1.0000 0.2250 1.2250 Year 3 1.0000 0.3375 1.3375 Year 4 1.0000 0.4500 1.4500 Year 5 1.0000 0.5625 1.5625

Total cost 1.1125

In the case borrowing, Xpresso needs $20,000,000 to open 20 cafes each year. We can assume that now the company has 40 cafes so their equity is around $40,000,000. That means their equity is double the total amount of money they need. Each year, they need $4,000,000 so their equity is 10 times. Debt Equity Debt to equity Year 1 20,000,000 40,000,000 50% Year 2 20,000,000 40,000,000 100% Year 3 20,000,000 40,000,000 150% Year 4 20,000,000 40,000,000 200% Year 5 20,000,000 40,000,000 250%

According to rule of thumb, the Debt to equity ratio should less than 1. If not, the company will not have enough money to pay for lender. 5. Comparison To be easy to compare the three options, we may compare the cost that Xpresso must pay for $1 each year. The cost that Xpresso pay for raising capital for each option will be compared by the table below. Total cost in 5 years 6.6875

Year 1 Borrowing 1.1125

Year 2 1.2250

Year 3 1.3375

Year 4 1.4500

Year 5 1.5625

Ordinary share Preference share

0.3033 0.1952

0.4767 0.2905

0.6990 0.3857

0.9811 0.4810

1.3360 0.5762

3.7961 1.9286

We can see very clearly that the cost that Xpresso must pay for borrowing in 5 years is much more than others. However, it is because the calculation assumes that the company has not paid for all debt yet for 5 years. If Xpressos business is quite good, they can pay for debt early and reduce the total cost much. Currently, Xpresso Delight Limited is growing up and they attract many investors (The earning growth projected at constant 15% per annum; their ordinary shares have outperformed in the past four years by an average of 40% per year). After paying all debt, Xpresso is free to do their business and they have not paid for anything. This is one of the advantages if the company decides to choose borrowing. Furthermore, is the company issue ordinary or preference share, suppose that they must pay dividends forever and this even increases the total cost much more than borrowing option. 6. Recommendation Compared any sources of finance for business expansion, we suggest Xpresso Delight Limited should cooperate both their capital and borrowing to finance the project. Firstly, they ensure that the flotation cost is not too big. Secondly, using their capital is much safer than any other sources. Thirdly, borrowing can bring much more profits for them than others as well as reduce the cost of debt capital. After paying all debt, the company does not have to pay for long debt if comparing to dividends which Xpresso must pay for their shareholders forever.