03-long term finance.ppt 1

IIM Calcutta EPGBM02Aug 2009

Sources of Long Term Finance

DR. U. K. BASU

udayan_basu@yahoo.co.in

Source of FinanceHow much of Long Term Project Finance and How much of Short Term Working Capital Finance?

Project Cost and Means of Financing

Project Cost

Project Cost for any Project includes:

1) All Non Current Assets required to be

acquired in connection with the project.

2) Margin on Working Capital

Project CostLand & Land Development

Building and Factory Shed

Plant and machinery

Misc Non Current Assets

(including Preoperative Exp) -----------------------

Non Current Assets

------------------------

Add Margin on Working Capital

to get the total Project Cost

Project Cost

Current Liability + (Term Liability + Tangible Net Worth) = Total of Liability Side of Balance Sheet = Total of Asset Side of Balance Sheet = Non Current Asset + Current Asset

Project Cost

Thus,

Long Term Finance = (Tangible Net Worth +

Long Term Debt/Liab)

= Non Current Assets +

(Current Assets –

Current Liabilities)

= Non current Assets +

Margin on Working Cap

Project Cost

In other words,

Project Cost = Long Term Finance required

for setting up the project

= Non Current Assets + Margin

on Working Capital

Project Cost

Liabilities Assets

Net Worth 500 Non Current Asset 600

Term Liability 200 Current Asset 400

Current Liab 300

Total------1000 Total------1000

Project Cost Margin on Working Capital = (Current Asset - Current Liability) = 100Long Term Finance = Non Current Assets + Margin on Working Cap = 600 + 100 = 700 = Net Worth + Long Term Debt = 500 + 200Term Loan of SBI is a part of Long Term Debt

The Complete Process

Company wanting to set up a Project

( a new, an expansion, a modernisation

or a diversification project)

Approaches SBI for a Term Loan

The Complete Process

SBI examines the DPR (Detailed project

Report submitted by the company).

Check for: 1) Technical Feasibility

2) Financial Viability

The Complete Process

For Financial Viability : -

Employ Capital Budgeting Techniques

( NPV, IRR, Payback Period etc.).

The Project is acceptable only if it is both

Technically Feasible and Financially Viable

The Complete Process

For Technical Feasibility: Check (A) The Process (B) The Installed Capacity (C) Availability of all Inputs including Power, Water, Skilled Labour, Raw Material (D) Market Demand (Global Demand Supply Gap; WTO)

The Complete Process

For Financial Viability : - Employ Capital Budgeting Techniques ( NPV, IRR , Payback Period etc.)

Any Project is acceptable only if it is bothTechnically Feasible and Financially Viable

The Complete Process

Assuming the Project is acceptable and the

Project Cost is in order, take a look at the

“Means of Financing”.

Capital Structure for the Project, i.e. how

much Long Term Debt & how much Equity

are to be used for financing the Project

The Complete Process

The Project Debt : Equity Ratio may be 1

(i.e. Debt and Equity both at 50% of the

Project Cost) or 1.5 (i.e. Debt at 60% &

Equity at 40%). Besides, a minimum

contribution by the Promoters, say at 15%

of the Project Cost, may also be necessary.

The Complete Process

In case the Project is acceptable (both

Technically Feasible and Financially Viable)

and the Project Cost as well as the Means

of Financing is in order, Bank can go ahead

with processing of the Term Loan Proposal.

Check the Debt Service Coverage Ratio.

The Complete Process

Once the processing is complete, the Bank

can go ahead with issuing a Sanction Letter.

But, NO DISBURSEMENT is to be made

until the Equity contribution is lined up by

the company (The Project can not be set up

only with Term Loan without the Equity).

The Complete Process

Once the company successfully makes a

Public Issue of Equity and the Project is

otherwise ready for implementation, the

Bank can start disbursement.

The Complete Process

With the entire Project Finance (Equity as well as Term Loan) already available, the company is to implement the project.

Once the project is already set up and the company is ready for commercial operation, the company approaches for Working Capital Finance from the Bank.

Sources of Finance

Long Term Finance (Project Finance)

Short Term Finance (Working

Capital)

Sources of Long-term Finance

Share CapitalLong-term Debt

Equity Preference

DomesticInternational GDR/ADR etc.

Retained Earnings (Dividend

Policy)

New Issue

Public Issue Rights Issue

Term Loans

Lease

Rupee Foreign Currency

(ECB)

Bond / Debenture

International Domestic

Foreign Currency

Bond

Euro Bond

NCD

PCD

FCD

Sources of Long-term Finance

Share CapitalLong-term Debt

Equity Preference

DomesticInternational GDR/ADR etc.

Retained Earnings (Dividend

Policy)

New Issue

Public Issue Rights Issue

Term Loans

Lease

Rupee Foreign Currency

(ECB)

Bond / Debenture

International Domestic

Foreign Currency

Bond

Euro Bond

NCD

PCD

FCDINTERNATIONAL FINANCE

Issue of Ordinary Shares Eligibility Norms

– Unlisted Companies:

Initial Public Offer (IPO)

Track record of Distributable Profit (in 3

out of last 5 years)

Net Worth >=Rs1Crore (in 3 out of last 5

years of which last 2 years must count)

Condition in case of Change of Name

during last one year

Public Issue of Shares

Book-building process, with at least 50% allotted to QIBs, 35% to Retail Investors & 15% to HNIs. New Guidelines for Book- Built Issues: QIBs have to apply with 10% margin money and there will be proportionate allotment for them also.

Issue of Ordinary Shares

• Existing Unlisted Companies

• Initial Public Offer (IPO)

• Newly established Company

No Track Record; In such a case,

Projections be appraised by a Bank,

which must have at least 10% Exposure.

Right Issue of Equity Shares• Selling of Ordinary Shares to the existing shareholders of

the company.• Value of Right • Letter of Offer• Right Renunciationx sp p

rn

International Equity Offering

GDR (Global Depository Receipt)

ADR (American Depository Receipt)

Denominated in US Dollars.

1) Why are these necessary?

2) How are they issued?

International Equity Offering Process

1. Project to be implemented: Project Cost; Means of Financing; Project

Capital Structure Whether Project is (a) Technically Feasible & (b) Financially Viable2. Necessary Approvals for the issue (Shareholders’ approval; FIPB Clearance, wherever necessary)

International Equity Offering Process

3. Appointment of Merchant Banker (s)

4. Drafting of Prospectus

5. Countries where issue to be launched

6. Road Shows

7. Book Building

8. Structuring the issue/instrument

9. Actual Issue of GDR/ADR & Listing

International Equity Offering GDR/ADR Issue Process

IssuerCompany

Domestic Custodian

GlobalDepository

Ordinary Rupee Shares

Confirmation

GDR/ADR Investors

GDR/ ADR Investors - Risks

The investors of GDR/ADR have twin risks.

The value of their investments decreases if:

1) The price of the underlying ( Indian ) share declines.

2) The value of Rupee ( Indian Currency )

aaadecreases vis-a vis the US Dollar.

Bonds / Debentures

FCD – Fully Convertible Debentures

Full face value of such a Bond / Debenture

is to be converted into Equity Shares either

at one shot or in more than instalment.

Features of a Bond

1. Face Value - Rs 1000

2. Coupon Rate - 12% p.a.

3. Frequency of Interest Payment / Compounding – Annual

4. Tenure - 5 years

5. Redemption - Bullet, at a Premium

of 10%

6. Market Price - Rs 1200

Cash Flow from a Bond

Time Interval Cash Inflow Present Valueend of h.y. 1 Rs 120 Rs 120 /(1+r) ,, ,, ,, 2 Rs 120 Rs 120 /(1+r)^2 ,, ,, ,, 3 Rs 120 Rs 120 /(1+r)^3 ,, ,, ,, 4 Rs 120 Rs 120 /(1+r)^4 ,, ,, ,, 5 Rs (120+ Rs1220/(1+r)^5 1100)

Foreign Currency Bond

Foreign currency Bonds

Foreign Currency

Bond

Floating RateNote (FRN)

Foreign CurrencyConvertible

Bond (FCCB)

YankeeBond ($)

Bull DogBond (GBP)

Samurai Bond (JPY) Dragon Bond

(Hong Kong $)

Domestic Bond

Euro Bond

Preference Shares• Similarity to Ordinary Shares:

Carries Dividend rather than Interest.

Dividends are not deductible for tax

purposes.

Paid out of Profit and NOT by debit

to P&L A/C. No Profit, No Dividend.

Preference SharesSimilarity to Debentures:

Fixed Tenure & Specified Dividend

Rate.

Do not share in residual earnings.

Usually do not have voting rights.

Payment in preference to Equity

Shares.

Preference Shares–Features

• Claim on Income and Assets. Between Creditors and Equity Shares

• Fixed Dividend and Maturity Period

• Cumulative Dividend (in some cases)

• No Voting Rights

• Convertibility

• Qualifies as Tier II Capital for Banks

Preference Shares

• Advantages for Issuers

• Fixed Dividend (out of profit only)

• No Voting Rights (No Dilution)

• Advantages for Investors

• No Tax on Dividends

Preference Shares–Pros and Cons

• Disadvantages

•Non - deductibility of

Dividends for Tax purposes

Cases where Preference

Shares work : Tax Angle

A Comparative Chart

• Bond Preference Share Equity Share• Fixed Tenure Fixed Tenure Perpetual Security • Pays Interest Pays Dividend Pays Dividend• Interest Rate Dividend Rate Dividend never pre-determined pre-determined pre-determined • Interest payable Dividend payable Dividend payable irrespective of only if sufficient only if sufficient profit profit is available profit is available (after payment of preference Dividend)

A Comparative Chart

5 No ownership No ownership Ownership No voting right No voting right Voting right6 In case of liquidation of company, Bond-holders Preference share Equity share are paid first holders are paid holders paid (along with after creditors last (after other creditors) creditors and Preference share)