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Financing – Equity finance

The financing decision

1.1 Debt or equity finance

The financing decision has already been identified as one of the three key decisions
of financial strategy (along with the investment decision and the dividend decision).

The key decision is whether to use equity or debt finance.

Consider:

 cost of the different sources of finance (kd < ke)

 duration – for how long is finance required?

 lending restrictions – for example security and debt covenants

 gearing level (also called capital structure)

 liquidity implications – the ability of the business to service the new
debt, allocating sufficient cash resources to meet interest and
capital repayment obligations

 the currency of the cash flows associated with the new project

 impact of different financing options on the financial statements,
tax position and financial stakeholders of the entity

 availability – availability of finance depends on the
creditworthiness of the borrower and also the willingness of
lenders to extend credit (for bank borrowings) or liquidity of the
capital markets (for equity and bonds).

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