THE FINANCING DECISION
The financial manager`s
second responsibility is to raise the money to pay for the investment in real
assets. This is the financing decision. When
a company needs financing, it can invite investors to put up cash in
return for a share of profits or it can promise investors a series of fixed payments. In the first case, the investor
receives newly issued shares of stock and becomes a shareholder, a part-owner
of the firm. In the second, the investor becomes a lender who must one day be
repaid. The choice of the longterm financing mix is often called the capital structure decision, since capital refers to the firm`s
sources of long-term financing, and the markets for long-term financing are
called capital markets.5
Within the basic
distinction issuing new shares of stock versus borrowing money there are
endless variations. Suppose the company decides to borrow. Should it go to capital markets for long-term debt
financing or should it borrow from a bank? Should it borrow in Paris, receiving
and promising to repay euros, or should
it borrow dollars in New York? Should it demand the right to pay off the debt
early if future interest rates fall?
The decision to invest in a
new factory or to issue new shares of stock has long-term consequences. But the
financial manager is also involved in
some important short-term decisions. For example, she needs to make sure
that the company has enough cash on hand to pay next week`s bills and that any spare cash is put to work to
earn interest. Such short-term financial decisions involve both investment (how
to invest spare cash) and
financing (how to raise
cash to meet a short-term need).
Businesses are inherently
risky, but the financial manager needs to ensure that risks are managed. For
example, the manager will want to be
certain that the firm cannot be wiped out by a sudden rise in oil prices
or a fall in the value of the dollar. We will look at the techniques that managers use to explore the future and some
of the ways that the firm can be protected against nasty surprises.
Self-Test 2 Are the following capital budgeting or financing
decisions?
a. Intel decides to spend
$500 million to develop a new microprocessor.
b. Volkswagen decides to
raise 350 million euros through a bank loan.
c. Exxon constructs a
pipeline to bring natural gas on shore from the Gulf of Mexico.
d. Pierre Lapin sells
shares to finance expansion of his newly formed securities trading firm.
e. Novartis buys a license
to produce and sell a new drug developed by a biotech company.
f. Merck issues new shares
to help pay for the purchase of Medco, a pharmaceutical distribution company.
4 Accountants may treat
investments in R&D differently than investments in plant and equipment. But
it is clear that both investments are
creating real assets, whether those assets are physical capital or
know-how; both investments are essential capital budgeting activities.
5 Money markets are used for short-term
financing.
CAPITAL STRUCTURE
Firm`s mix of long-term financing.
CAPITAL MARKETS
Markets for long-term financing.
Category: Cash flows
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