Cost benefit analysis is conducted in order to evaluate how well, or poor a planned business expansion action will turn out. Even though, it can be conducted on almost everything, it is usually conducted for financial purposes. Cost benefit analysis is also known as a running number. This is because it involves summation positive aspects of an action and subtraction of negative ones in order to assess the net result (Frost, 2008). A cost benefit analysis is usually used in financial and business firms, generally in quantification of positive and negative aspects of a proposed business action. The gap between the two aspects indicates whether the proposed action is feasible or not. However, the real trick in conducting a comprehensive cost benefit analysis is ensuring that all cost and the benefits are properly quantified.
Gulf food is a large company involved in food distribution business in the Abu Dhabi. After review of its financial performance, it has found that the profits are stable. It is projected that the average growth rate within the next 5 years will be approximately 8 percent. In addition, the debt equity ratio has also declined from the 1.5 to approximately 0.75. In terms of sales growth and return investment, the company has realized an enormous growth. On the basis of sale growth and return on investment to date and the projections from the finance department, the company has decided to expand it new market in the area. The company is intending to open two new branches in Asia. The company intends to raise capital through bank loans, issues of bonds and issue of shares in order to fund it expansion projects. While deciding on the possible source of fund, the finance department has reviewed the economic condition and found that the economy would maintain the growth momentum for the next 5 years. This paper assesses the feasibility of raising the capital using the above means in order to fund the expansion project.
Bank loans will be a crucial source of funds for Gulf Food Company project. This is because in order for the Company to make the expansion project a reality, it will be required to take loans from the bank. However, this will need and effective financial planning and strategizing to ensure the loan will help the company realize its expansion goals and objective without risking being trapped in a debt (Frost, 2008). Raising capital from bank loans has both benefit and consequences that need to be weighed carefully. This because taking a loan from a bank mighty is usually expensive to the Company. In addition, it will raise the risk to the financial state of the company.
Capital obtained from the loan will be useful for the Gulf Food Company. This is because it will provide the working capital required to manage the day to day project operations. The Gulf Company is financially capable of securing a loan from a bank since its debt equity ratio is declining. Therefore, this will give it an upper hand when securing the loan. The current investment returns to the company makes it possible to secure a bank loan in the form of mortgage, which will provide the company with an ample time to repay without compromising it financial position. Long time bank loans normally take 25 to 30 years (Frost, 2008). In addition, with regard to the current financial performance of company, it has enough collateral to have loan
Using equity financing from the bank as means of raising capital for the expansion project will be beneficial to the Gulf Food Company. This is because the company will be in a position to service the borrowed amount in a fixed time. Furthermore, the company will be able to focus on ensuring that the outcome of the expansion project is profitable instead of worrying on how to pay back the loan bank (Frost, 2008). However, it is crucial for the Gulf Food Company to understand that using equity financing to raise capital may pose some risk to its business.
The Gulf Food Company may end up losing complete or partial control over their new business. This is because the bank will often be involved in the decision making process due to the large share of their equity invested on the project. The Gulf Food Company can alternatively seek debt financing from the bank. This will be beneficial because the company will retain a complete control of its new and existing business. However, the company will need to make a careful consideration before using debt equity to raise capital. This is because high debt may be unattractive to other investor involved to the expansion project. High debt will be likely to discourage other potential expansion project financiers from lending further to the project. As a result, the Gulf Food project will lose an opportunity to raise enough capital required to actualize the expansion project.
Issue of bonds
A bond can be termed as a loan in the arrangement of a debt security. Gulf Foods can consider the positive impacts that it may realize through the issue of bonds over other methods of raising capital (Hay%u02BCat, 2011). This is a popular alternative that some leading companies have used and realized their expansion goals. Issue of bonds will allow Gulf Foods Company to avoid surrendering ownership of part the company. Gulf Food may choose authorized issuer of its bonds. As a result of high interest rates that are associated with bank loans, companies across the world have realized that they cannot only depend on banks for money (Hay%u02BCat, 2011). Gulf Foods has an option of issuing bonds as a method of raising extra money for growth and expansion. Through bonds, Gulf Food Company will get money from the public or other organization. It is a cheaper method compared to securing a loan from a bank. A bond has a lesser interest rate equaled to that of a bank, and different stock, a bond does not necessitate the issuer giving up control over the company (Withers, 2006).
Issuing bonds will prove to have more benefits unlike other alternatives of raising capital. Apart from helping Gulf Food Company raise more money for developmental goals, bonds will help monitor the company general health. Financing the company expansion projects will prove to be useful to the company in reflecting the financial stability without compromising the ownership of the company (Hay%u02BCat, 2011). Bonds will also offer a safe return to the stakeholders or investors. Gulf Food will need an underwriter to help in issuing bonds. This is an investment bank that Gulf Food chose. The underwriter will help the company begin the process of giving out bonds by defining the details of the bond. The company may follow several steps to successfully issue bonds and collect the projected amount of capital. The company stakeholders must first agree that issuing bonds is a crucial choice of raising capital (Withers, 2006).
The amount that Gulf food company need may exceed what local banks can afford or provide. Bonds can thus set in as an alternative. In issuing bonds, debt issuance can be beneficial from an authority point of view. Bonds will be cheaper than taking an overdraft from a bank. What is more significant is that the yield on interest tax is deductible. On the other hand, the return on equity, which is dividends, is paid out of the company’s profits, which are taxed before dividend disbursements can be made to bond holders (Withers, 2006).
However the issue of bonds does not mean it is free from shortcomings. In determining the best method of raising capital, Gulf Food Company must take into account that the peril for bond holders increase as additional debt is issued. The signed debt agreements may attest too limiting for Gulf Company (Hay%u02BCat, 2011). The company may become highly leveraged and may experience cash flow hitches. It has to cater for the coupon expenditures irrespective of its income. This may make the cost of servicing the debt raise beyond a point that paying back to the public becomes an issue. These problems may come because of external aspects that are beyond the company’s control. These are problems like falling income and internal problems like poor management of the company (Withers, 2006).
Additionally, issue of bonds in a case where Gulf Food Company is listed or has future plans of being listed in the stock exchange increase risk to the stockholders. This is due to an increase in debt issued (Vance, 2005).
Issue of Shares
Gulf Food Company has also an alternative of selling or issuing shares. The company will first need to register in the stock exchange so as to sell its shares to the public. Gulf Food can prepare an initial public offering that is IPO. How much money can be realized through an IPO relies fairly on the apparent value (Hay%u02BCat, 2011). Through this offering, the company will be prized and an opening price of its shares determined. Another confirmed way of trading stock in a private situation. This not only avails the needed capital for the company, but also helps the company keep control over who turns out to be a shareholder in the company (Withers, 2006). Gulf Food company will need the approval of its board and all stakeholders.
In an attempt to raise more money for Gulf Food Company, issue of share will have both the positive and the negative side. Incase Gulf Food company has gotten to a certain magnitude and has a resilient reputation; an IPO can be a worthy method of raising a large sum of the needed capital. This will help the company achieve its set goals and objectives. In Issuing shares, Gulf Food Company will not repay the share capital. Instead, the company only agrees to allot future profits to shareholders in return for their investment (Hay%u02BCat, 2011). Finally another advantage of using the share as a source of capital is that, once listed, Gulf Food will be able periodically offer further shares.
A significant short coming of issuing shares as a source of capital for a company is that, through IPO, the real company owners no longer have full control (Vance, 2005). They become more accountable to stakeholders and may derail decision making in the company. Shareholders can block development plans that they believe to pose reasonable risk to their investment.
It is vital that any company wishing to borrow money for developmental projects outlines both the short term and long terms goals. Gulf Food Company may opt to choose a combination of two or all the three available options. This will minimize or counter the disadvantages associated with any of the above discussed method of obtaining capital for expansion. Financial planning is the key aspect to the realization of goals and objectives of the expansion project. Since the company has a good credit history as reflected by the declining equity debt ratio, it will be essential for the company to take a loan. However, the Company will be required to explore various rates charged by banks to ensure it settles on the right repayment plan (Economic Development Council of New York City, 2007). This can be achieved through the support of venture capital firms so as to take an offer with lucrative rates when raising the capital. It is also worthwhile for the company to integrate all options of raising fund available other than the bank. The issuing of stocks is also an effective way of raising capital. The company performance indicator reports a progressive profit growth from 10 to 20 percent between 2005 and 2012. This means that the buyers will have privilege shares in the company. Therefore, their inclusion in raising the capital will provide a large resource base for the project. Using bond is the most appropriate means of rising raise the capital. This is because the interest rate on the bond is normally lower than any other type of loan (Economic Development Council of New York City, 2007). Therefore, the Gulf Food Company needs to use all the available options in raising the capital during different stages of the project. However, more stress ought to be given to the issue of bond due to low interest rates associated with them.