Introduction
Background information
ACME is a multinational enterprise (MNE) with operations in the United States, Asia and Europe. The firm deals with the manufacture of integrated portable computers. In designing the computers, the firm’s engineers are dedicated to ensuring that these computers are designed and produced according to specification (ACME, 2010, par. 1-2).
To attain a competitive edge in the market, the firm’s management team has formulated an international expansion program. The program entails the implementation of the Greenfield investment overseas. A firms requires a substantial amount of financial resources to successfully undertake its internationalization process (Xunta de Galicia, 2008, par. 1).The firm’s management team estimates that the cost of acquiring the new production facility will be $500 million. The management team intends to use external sources of finances to implement this project. There are various sources that the firm’s committee charged with the responsibility of determining the sources of finance can consider. The paper reports on the financial aspects involved in acquiring the production facility by ACME.
Aim
The aim of the report is to identify and analyze the characteristics of various financial alternatives the firm’s committee can consider. In addition, the report aims at analyzing the advantages and disadvantages associated with the identified financial alternatives.
Scope
This report entails an evaluation of the various external sources of finance available to ACME. The sources considered include ownership and non-ownership financial capital. Ordinary and preference shares are the main source of ownership capital available to the firm. On the other hand, non-ownership sources include loans from commercial banks and investment companies. In analyzing the external sources, the report also includes the advantages and disadvantages associated with each identified source. However, the report does not determine the specific financial costs associated with the various alternatives sources.
External sources of finances
Ownership capital
Considering the fact that the firm requires finances for expansion, the management should consider long- term sources. One of the sources that the firm’s management team should incorporate is ownership capital. This source of finance refers to capital acquired from the public through issuing of shares. The management of ACME should consider issuing various types of shares to the general public. This can be achieved by conducting an Initial Public Offering (IPO) in relation to ordinary and preference shares through the stock exchange market. Investors who will purchase the company’s shares shall partly own the company. The management of ACME can develop limited preference shares for a given number of years. After the expiry of this period, the preference shareholders have the capacity to redeem their investment.
Advantages ownership sources of finance
These sources of finance are long- term in nature. Use of ordinary shares is a good form of financing for ACME to use since it acts as a permanent source of finance. In addition, the firm will not have a legal obligation to make a repayment to investors in relation to interest or the amount invested. This means that the management team is at discretion to commit funds to its expansion program.
Disadvantages
In the process of sourcing financial capital by issuing shares through an IPO, ACME will incur considerable amount of expenses. For instance, the firm will incur a significant underwriting cost to the lead underwriter. A lead underwriter refers to an investment bank that a firm selects to determine the offering price for the IPO. In addition, the lead underwriter is also charged with the responsibility of allocating shares. Ordinarily, the underwriting cost is determined as a function of the total amount received from the IPO. According to William (2010, par. 3), the United States through the National Association of Security Dealers (NASD), has set this percentage at 18% which is relatively high.
Increase in the number of ordinary shareholders through issuing of shares will result in the management team losing a substantial control of the firm.
By using preference sources of capital, the firm will have a legal obligation to make periodical interest payments to these shareholders. This may result in a financial constraint for the company especially during periods of poor financial performance.
Non-ownership sources of capital
ACME’s management team should consider incorporating various forms of non-ownership sources of finances. An example of the source which the management should consider is use of a bank loan.
Bank loan
The management team can consider credit sources of finance by borrowing from the local commercial and investment banks. These banks usually offer various loan packages to individuals and institutions depending with their financial requirements (Frank, 1998, p. 25). In an effort to expand ACME through the Greenfield investment, the management team of the firm should take a fixed loan in the amount of $500. Bank loans are linked to a predetermined rate of interest and are payable within a given time frame.
Advantages
Considering the financial strength of the firm, ACME may easily secure a bank loan from various financial institutions in the U.S. This is due the fact that the firm has a high credit worth rating. In addition, the firm will incur minimum cost in the process of securing the bank loan.
Disadvantages
Bank loan as an external source of finance results into a firm incurring high cost in the long term. For instance, the firm will have an obligation to pay a fixed amount of interest to the financial institution on periodical basis. This means that the firm might face financial constraints in its operation during poor economic periods since it will have to pay the interest rate. In addition, the cost of finance may increase since bank loans are susceptible to fluctuations (The 100 Times, 2010, par. 4). In securing a loan from a financial institution, ACME may be required to provide a form of collateral. The collateral may either be the firm’s financial or real asset which will be sold by the financial institution in the event of loan default. Collateral requirement means that some of the firm’s asset will be tied.
Factoring
Credit terms are incorporated in the operation of firms. As a result, firms have a considerable amount of finance in the hands of their debtors. The management of ACME should consider selling these debts to factoring company. The factoring company will collect the debts at a certain predetermined commission. This means that the firm will be able to boost its financial capital requirements through immediate debt collection. By using this method, the firm will lose some of its finances in the hands of creditors by paying a commission to the factoring company (The 100 Times, 2010, par. 4).
Conclusion
The process of undertaking internationalization involves a considerable a mount of financial resources. There are various external sources of finances that the management team of ACME can consider. These sources relate to ownership and non-ownership sources. Ownership sources of capital entail issuing various types of shares such as ordinary and preference shares to the general public. On the other hand, debt finance relate to sourcing for finances from financial institutions such as commercial and investment banks in the form of a loan. These sources have got a number of advantages and disadvantages.
Recommendation
- ACME’s management team should evaluate the interest rate charged by various commercial and investment banks in selecting the creditor to secure the loan from. The firm which charges the lowest interest rate should be selected.
- The firm’s management team should conduct a cost-benefit analysis in determining the external source of finance to use.
Reference List
ACME. (2010). ACME company profile. Web.
Frank, J. (1998). Bank loans: secondary market and portfolio management. New York: John Wiley and Sons. Web.
The 100 Times. (2010).External sources of finance. Web.
William, C. (2010). IPO costs. Online Information Library. Web.
Xunta de Galicia. (2008). Investing and financing: long term project financing. Web.