Question

Shalini, after acquiring a degree in Hotel Management and Business Administration took over her family food processing company of manufacturing, pickles, jams and squashes. The business was established by her great grandmother and was doing reasonably well. However the fixed operating costs of the business were high and the cash flow position was weak. She wanted to undertake modernisation of the existing business to introduce the latest manufacturing processes and diversify into the market of chocolates and candies. She was very enthusiastic and approached a finance consultant, who told her that approximately Rs. 50 lakh would be required for undertaking the modernization and expansion programme. He also informed her that the stock market was going through a bullish phase.
(a) Keeping the above considerations in mind, name the source of finance Shalini should not choose for financing the modernisation and expansion of her food processing business. Give one reason in support of your answer.
(b) Explain any two other factors, apart from those stated in the above situation which Shalini should keep in mind while taking this decision.

Answer 1

(a) Debt
Reason:
1. Due to weak cash flow position, the firm may not be able to honour fixed cash payment obligations.
2. Increased fixed operating cost will increase the business risk, therefore debt should not be issued as it further increases the financial risk
3. The stock market condition beingbullish, the investors will prefer to buy equity shares
(b) Other factors
Return on Investment
Tax rate
Cost of Equity
Floatation Costs
Flexibility
Control Consideration
Regulatory Framework
Capital Structure of other companies
Debt Service Coverage Ratio
Cost of Debt