Topic: There is a common phrase in business: cash is king. %u201CCash flow is th
ID: 2701549 • Letter: T
Question
Topic: There is a common phrase in business: cash is king. %u201CCash flow is the life-blood of a company. Without it, a company will fail (Hicks, 2012). Yet, companies often have to take risks that could potentially jeopardize their cash flow (e.g. new projects, growth, capital budgeting, etc.). Assume you are the CFO of a struggling company. While you do have a positive cash flow, it is minimal at best.
If something does not change soon, the company will go under. Fortunately, your product development team has just created a new product that will not only save the company from financial demise, but the product will revolutionize how the industry does business. The problem is that the product is still two years away before it can be sold to the public, and you will run out of cash within the next six months.
How would you propose obtaining the funds needed to keep the company alive and thriving for the next two years until you are able to see a return on the product development, and keep the stakeholders happy?Type your question here
Explanation / Answer
Now there can be two ways i could raise money. By borrowing(ie debt) or through equity. Now the problem of financial leverage vs credit risk comes into account. Going through the debt option will help reduce the cost of capital of the firm and thus would increase the value of the firm and is also a quick way to get money but raises the concerns of a credit rating downgrade. Equity on the other hand is an expensive way and also leads to dilution of the holdings but helps you get capital without reducing the credit rating.
Now given that i need cash for a short term i would not opt for the equity path. The reasons for the same would be that after two years when i start earning profits i have to share them with the new shareholders that i have acquired. whereas in case of debt i can just pay off the debt from the profits and then be better off going ahead. So i would try to borrow the sum sufficient to run the company for two years and then when the product is successfull i can pay it back. This ofcourse is under the assuption that the product will succeed in the market or else the company will be doomed. SO if you wanna be on the safer side then going for a fresh issue of equity will be chosen