Financial Management: Sources of Long-Term Finance, Financial Distress, and Optimum Capital Structure

Part 1: Financial Management
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Contents
Introduction......................................................................................................................................3
Task 1: Discussion on Attributes of the Basic Sources of Long-Term Finance..............................3
Long-Term Debt..........................................................................................................................4
Preferred Stock.............................................................................................................................5
Common stock.............................................................................................................................6
Lease Financing...........................................................................................................................7
Angel Investor..............................................................................................................................8
Task 2: Explanation of Financial Distress and its Direct and Indirect Costs on Corporation.......10
Task 3: Evaluation of optimum capital structure to maximize the shareholder’s wealth..............13
Optimum Capital Structure........................................................................................................13
Capital Structure as per Modigliani and Miller.........................................................................13
Financing Decision with WACC Techniques............................................................................14
Mixture of equity and debt that will result in lowest WACC and maximum value of market
value of company.......................................................................................................................15
Conclusion.....................................................................................................................................18
References......................................................................................................................................20
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Introduction
The businesses need to manage their financial resources in an adequate manner for
promoting their long-term growth and development. This is because they require continuous
supply of funds for their capital expenses, working capital and other long-term use of these funds
for promotion of their growth and development activities. It is therefore important for the
financial manager of a business corporation to take financing decisions in an adequate manner
for ensuring that continuous supply of funds is available to create value for the shareholders. The
main objective of financial management within a corporation is to ensure that adequate sources
of funds are available to overcome the financing problems that can occur due to lack of adequate
funds to conduct the daily business activities. As such, it is highly important for a financial
manager to take adequate decisions that lead to maximizing the value of business through proper
planning and management of financial resources that leads to minimize the financial risk and
leads to increasing its profitability position. In this context, this report has been prepared for
providing a discussion relating to the basic sources of long-term financing such as long-term debt
or preferred stock and others. Also, it provides an explanation of the financial distress and the
direct and indirect costs related with it. This is followed by conducting an analysis of the
optimum capital structure required to be maintained by a corporation for maximizing
shareholders wealth.
Task 1: Discussion on Attributes of the Basic Sources of Long-Term Finance
Long-term financing sources for a business corporations is required to meet the capital
requirements for a long-term financial period. The capital expenses incurred by a company in
purchasing fixed assets such as plant, machinery, land and others are funded with the use of
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long-term sources of finance. In addition to this, the businesses also adopt the use of long-term
sources of financing for meeting their working capital requirements. The major sources of long-
term financing that are used by business besides equity and debt capital is discussed as follows:
Long-Term Debt
The long-term financing used by a business through debt sources can be mainly
categorized into loans and debentures. Debentures are long-term debt instrument that are utilized
by companies to borrow funds at a fixed rate of interest from general public. On the other hand,
term loans are provided by a financial institution such as bank having a fixed rate of interest and
that need to repay in installments. The major advantage and disadvantages associated with the
use of this long-term debt financing are discussed as follows:
Advantages
 Long-term debt financing is less costly method of gaining funds for businesses as interest
on debt in subjected to tax deductions and it is also regarded as having lesser financial
risk
 It enables the business in promoting long-term growth by acquiring assets that require
major funds such as purchasing land or building or investing in research and development
activities supporting the business expansion
 The bondholders or creditors does not have ant stake in business and thus do not interfere
in business activities (Rossi and Matteo, 2016).
Disadvantages
 There exist a financial risk of not able to meet the interest obligations on these sources of
finance in a timely manner
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