Sources of Finance Notes

Sources of Finance Introduction

• Focuses on raising money for investments in a business.

Objective and Learning Outcomes

• Understanding types of financing required by businesses at various stages of development.

• Learning Outcomes:

  • LO 1: Identify stages of business development and financing available at each stage.

  • LO 2: Explain different markets and methods of raising money (debt and share capital).

  • LO 3: Justify choice of one form of finance over another.

  • LO 4: Calculate cost of each financing form and determine Weighted Average Cost of Capital (WACC).

Types of Capital

• Categories of Capital:

  • Debt: Includes Loans and Bonds.

  • Equity: Focus on Ordinary Shares, with few preference shares issued in New Zealand.

  • Various financial markets serve as sources for lenders and investors.

Financial Markets for Raising Funds

• Companies need to connect with individuals or companies possessing funds. These connection points are referred to as financial markets.

• New Zealand previously had limited financial markets predominantly through banks and the New Zealand Stock Exchange.

  • Financial Markets Conduct Act 2013 (FMC Act): Introduced new marketplaces, allowing for Crowdfunding.

Crowdfunding

• A financial market service facilitated by the FMC Act, companies can raise up to $2 million annually without the need for complex disclosures.

• A crowdfunding service acts as an intermediary, typically through online platforms.

• Distinction: Crowdfunding is not applicable for charitable fundraising not involving shares.

Peer-to-Peer Lending / Crowdlending

• Online platforms that connect borrowers with willing lenders, available for both personal and business loans (P2B).

• Offers alternatives to bank loans, allowing businesses to raise capital through ordinary individuals.

Traditional Bank Loans

• Companies often seek loans from banks, which serve as intermediaries.

• Banks fund their loans through deposits from customers and charge a higher interest rate on loans than the rate they pay on deposits.

• Loan Nature: Typically, "floating rate" loans linked to recognized base rates (e.g., LIBOR, EURIBOR, BKBM in NZ).

Costs of Bank Loans

• Cost Calculation:

  • Based on benchmark rates plus risk margins.

  • Example: Kathmandu's multi-option facility agreements involve BKBM rates plus a margin.

• Risk Factors: Banks consider company loans riskier than interbank loans, leading to higher interest rates.

Example: Kathmandu's Loans

• Multi-option facility agreements with repayment schedules detailing amounts and interest rates linked to BKBM and other short-term rates.

Bond Markets

• Listed companies can also raise funds via the bond market.

• New Zealand Stock Exchange provides access to a broad array of corporate and governmental debt options.

• Over 140 bond issues listed on the NZDX, with significant financial figures involved.

Bond Characteristics

• Most bonds pay interest only until maturity; interest varies from coupon rates based on market conditions.

• Market Rate and Coupon Rate explained as crucial for understanding a bond’s value and pricing.

Analysis of Market Rates

• Different borrowing entities (e.g., NZ Government, Auckland Council) offer varied rates reflecting their risk profile.

• Interest rates adjustable based on market dynamics.

Cost of Debt & Tax Implications

• Loan interest payments are tax-deductible expenses, reducing taxable profit.

• Formulae for cost impact:

  • Cost: $D imes rD = ext{Interest Expense}$

  • Refund Calculation: $ext{Interest Expense} imes T$

  • Effective Interest Paid: $(D imes rD) imes (1 - T)$

  • Effective interest rate: $rD imes (1 - T)$

  • Here, (D) = Amount of Loan, (rD) = Annual Interest Rate, (T) = Company Tax Rate (28% in NZ).

Conclusion and Next Steps

• Review calculations and implications of financing decisions towards assets financing.

• Ensure understanding of the various financial tools available for business funding decisions.