FINANCIAL DECISIONS

Financial Decisions

Financial Decisions

Task 1

1.1

Since London Woods is not listed on the stock exchange it will not have access to capital markets to raise finance. Though it can raise the four million pounds required via long term loan. The machinery will have a useful life of five years and thus long term finance can be considered. London Woods does have retained earnings carried forward from its prior year of operation that can be used. Since London Woods generates significant employment and is seen as public interest, it can request finance from government sources in the form of grants. Business expansion scheme funds can be availed if such a scheme is offered by the UK government. Funds from venture capitalist and franchising do not sound appropriate for London Woods. Neither does selling surplus assets to raise finance. Arrangements such as hire purchase and finance lease sound like a realistic option (Fao.org, 2007).

1.2

Raising finance from long term borrowing will affect the profitability and liquidity of London Woods. Interest cost will accelerate thereby reducing profits which already are shrinking ($510 in 2011 to $370 in 2012). The finance charge will affect the liquidity of London Woods as a cash payment of $480,000($4m*0.12) will be made to the lenders. Using prior year retained earnings to finance the purchase will lower this year's total shareholder's fund which means lesser profits will be available to distribute. Using government grant will mean slavery to the government; grants often come with strings attached and compliance to their conditions is required in order to keep the funds coming. Compliance to them will add to costs and lower profitability. Since UK has been affected by the economic turmoil the government has several business expansion schemes. It will benefit London Woods by providing a cheap source of finance. Hire purchase of machinery will keep the liquidity position healthy and profits equally matched.

1.3

Long term loan finance is something London Woods might consider. It has its own advantages and disadvantages. Debt is a cheaper source of finance as interest on it is tax deductible. Secondly the ownership of the company is not diluted as lenders do not subscribe for ownership rights and do not possess the right to vote. Disadvantages of long term debt finance include finance charge as timely interest payments is a regular burden for the company. Irrespective of whether London Woods is in profit or not it will have to pay interest. There is a fixed maturity date which means that a follow up must be in place. It is very risky as creditors can file the company for liquidation if London Woods fails to pay interest and principal on time. Another appropriate source of finance is hire purchase. The biggest benefit is that payment is made in instalments and does not require immediate upfront cash. Drawback is that it costs slightly more as the lessor incorporates interest, inflation and risk in repayments.

Task 2

2.1

Where there is capital there are associated costs of ...