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Financial Management I

3. Sources of Long-Term Finance

Dr. Suresh suresh.suralkar@gmail.com Phone: 40434399, 25783850

Course Content - Syllabus


Sr Title ICMR Ch. PC Ch. IMP Ch.

1 Introduction to Financial Management


2 Overview of Financial Markets 3 Sources of Long-Term Finance 4 Raising Long-term Finance

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2* 10*

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5 Introduction to Risk and Return


6 Time Value of Money 7 Valuation of Securities 8 Cost of Capital 9 Basics of Capital Expenditure Decisions 10 Analysis of Project Cash Flows and Optimal Capital 11 Risk AnalysisDecision Expenditure

*Book preference

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Sources of Long-Term Finance


Reference Books 1. Financial Management, ICMR Book, Chapter 10 2. Financial Management, Prasanna Chandra, 7th Edition,

Chapter 17
3. Financial Management, I. M. Pandey, 9th Edition, Chapter 20, 21
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Syllabus Sources of Long-Term Finance


1. Equity Capital and Preference Capital 2. Debenture Capital 3. Term Loans and Deferred Credit

4. Government Subsidies
5. Sales Tax Deferments and Exemptions

6. Leasing and Hire-Purchase


7. New Instruments
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Introduction
Typical Balance Sheet Liabilities Share Capital 30 Equity 25 Preference 5 Reserves and Surplus 20 Secured Loans 25 Term loans 15 Cash Credit 10 Unsecured loans 10 Bank Credit 4 Inter-corporate 5 Deposits 1 Current Liabilities and Provisions 15 Trade Credit 10 Advances 3 Provisions 2 Total Liabilities 100 Assets Fixed assets (net) Gross Block 80 Acc. depreciation 20 Investments Current assets, loans and advances Cash at hand 5 Debtors 12 Inventories 13 Advances 3 Misc. exp. and losses 2 50

15 35

Total Assets

100

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Introduction
Finance requirements Long-term finance Short-term finance: Working Capital requirements Long-term finance is required for Setting up of a firm, buildings and machinery, expansion, diversification, modernization etc. These decisions require large investments, benefits of which are achieved on long-term and these decisions are irreversible in nature. These decisions require proper asset-liability management. Asset-liability mismatch occurs if longterm requirements are funded by short term sources of finance. Such mismatch leads to interest rate risk and increasing interest burden on firm and the liquidity risk.

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1. Equity Capital and Preference Capital


Equity Capital Equity shareholders are the owners of the business. They enjoy the profits of the company after having paid to preference shareholders and other creditors of the company. Their liability is limited to the amount of share capital they contribute to the company. Equity capital is a permanent capital with the company and no obligation for dividend payments. However cost of equity capital is higher than other capital. Equity shareholders enjoy the voting rights. Excess equity capital leads dilution of effective control.

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1. Equity Capital and Preference Capital


Preference Capital Preference shares have some attributes similar to equity capital and some to debentures. Preference shares have first right on the dividend payment and assets in the event of liquidation, over the equity shareholders. Preference shareholders get fixed rate of dividend e.g. 18% preference shares. As per Companies Act 1956, preference share holders do not have voting rights except certain cases. Preference capital might include call feature, where an issuing company has an option to redeem the shares, wholly or partly, prior to the maturity date and at a certain price. 8 / 17

1. Equity Capital and Preference Capital


Types of Preference Capital Cumulative Preference shares, where dividends are paid on a cumulative basis in case they remain unpaid in any financial year due to insufficient profits or loss. The company have to pay up all the arrears of preference dividends before declaring any equity dividends. Non-cumulative Preference shares do not enjoy above right to dividend payment on cumulative basis. Redeemable Preference shares will be redeemed after a given maturity period. Perpetual Preference share capital will remain with the company forever. Convertible and Non-convertible Preference shares, whether to convert into equity shares or not, after certain period. 9 / 17

2. Debenture Capital
Debentures are issued by the company usually for longterm debt. Debentures get a fixed rate of interest or floating rate of interest or zero rate of interest (zero coupon) e.g. 12.5 % Reliance Convertible Debentures. Debentures are usually secured on the immovable property of the company.

Trustee is appointed, usually a bank or financial


institutions or an insurance company. Trustees role is to

protect the interest of the debenture holders.

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2. Debenture Capital
Maturity: Corporate debentures may be short-term, medium-term or long-term. Short-term corporate debt of less than one year is called commercial paper. Medium-term debentures have maturity 1 to 5 years and

long-term debentures 5 to 15 years.


Debenture types:

Fully Convertible Debentures


Partly Convertible Debentures Non-convertible Debentures
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3. Term Loans and Deferred Credit


Term Loan is a debt for long-term finance, generally for

more than 1 year up to 10 years. These term loans are


offered by the financial institutions e.g. IDBI Bank, ICICI Bank and SFIs. Term loans carry fixed rate of interest and are secured against companys immovable assets. Financial institutions appraise a project and assess a credit risk, then issues the term loan.

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3. Term Loans and Deferred Credit


Deferred credit is provided by the suppliers of the

machinery, whereby the buyer company can pay the


purchase price in installments, over a period of time. Bill Rediscounting Scheme, Suppliers Line of Credit, Seed Capital Assistance and Risk Capital Foundation Scheme are the examples of the deferred credit schemes offered by the financial institutions.

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4. Government Subsidies
The central and state government provides subsides to

the industrial units in the backward areas. The central


government has classified the backward areas into districts A, B and C. The state government also offers cash subsidies to promote industries.

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5. Sales Tax Deferments and Exemptions


To attract industries, the state governments provide incentives in the form of sales tax deferments and exemptions. Under sales tax deferments, the payment of sales tax may be deferred for 5 to 12 years. Under sales tax exemptions, some states exempt the

payment of sales tax applicable to the purchase of raw


materials, consumables etc. supplied within a state. The

period of exemption ranges from 3 to 9 years.

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6. Leasing and Hire-Purchase


Leasing is a contractual agreement wherein the company (lessee) can enter into lease deal with the manufacturer

of the equipment (lessor) or through some other


intermediary. This deal gives the company the right to use the asset. Hire-purchase is similar to leasing, except that in hirepurchase the ownership will be transferred to the buyer after all the installments are paid-up. Leasing and hire-purchase are offered by financial institutions, NBFCs, banks, manufacturers of

equipments / assets.

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7. New Instruments
Non-voting Shares Detachable Equity Warrants: Issued with nonconvertible debentures or other debt and equity. Participating Debentures: which participate in the profit of the company. Participating Preference Shares Convertible Debentures with Options Third Party Convertible Debentures Mortgage-backed Securities Convertible Debentures Redeemable at Premium Debt-equity Swaps Zero-coupon Convertible Note
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