Beruflich Dokumente
Kultur Dokumente
Name:
Instructor:
Date:
FUNDAMENTALS OF CORPORATE FINANCE 2
Question One
Abeer Inc. has debt claims of $400 (market value) and equity claims of $600 (market
value). If the after-tax cost of debt financing is 11 percent and the cost of equity is 17
Any corporation having debt claims worth $400 and equity claims worth $600 is said to
be 60% equity-financed and 40% debt-financed. Abeer Inc. cost of capital will be calculated
using WACC formula which considers both the cost of equity and that of debts.
WACC = (equity cost * weight) + (after tax cost of debt * Weight of debts) where cost of
equity is 17%, weight of equity is 60%, cost of debt after tax is 11% and weight of debts is given
by 40%
Question Two
Arabia?
Venture Capital (VC) consists of private equity financing that financiers extend to small
businesses and young entrepreneurs having great potential to grow. Saudi Arabia is a nation
currently a hub for attracting young entrepreneurs. According to Ashri (2019), 76.3 percent of
adult Saudi Arabians are now starting businesses. Venture Capital is playing a significant role in
FUNDAMENTALS OF CORPORATE FINANCE 3
The established VC firms in Saudi Arabia are geared towards extending assistance to
SMEs with the primary goal of advancing economic growth in the country. They invest their
time to understand the various needs of the entrepreneurs; these firms are aiming at not only
profit but also on the creation of sustainable jobs and economic diversification in the country,
thus having the interests of the whole country at large. In other countries, Venture capitalists are
Question Three
Under what conditions do you think that the finance manager does not have to think about
Financial management is the process that is concerned with sourcing funds and the
utilization of such funds to meet the goals of the company. Capital structure decisions are
essential for finance managers at this stage. Capital structure helps in identifying the required
mix or combination of debt and equity as sources of financing. Managers need to depend less on
debts, thereby maximizing shareholders' value. However, there are some conditions in which the
manager does not care about the considerations for capital structure.
The first condition is when the firm is making enough revenues to meet the operations of
the company. An organization can be generating enough cash flows, which can cater to all the
activities of the company ranging from all expenditures and financing assets acquisition. For this
reason, the manager will be unmoved concerning the distribution of debt and equity financing,
and since there is no debt financing, the manager only has one function of maximizing the
shareholders' value by paying them retained earnings at the end of the year.
FUNDAMENTALS OF CORPORATE FINANCE 4
Another condition is when the new project being launched by the company is not likely
to change the company's capital structure. An organization may wish to implement a new project
that will not require sourcing for financing. In a University setting, for example, where a new
program on entrepreneurship is established to sponsor SMEs, where the source of funds was
through the sale of books and fundraising. Then this will not require giving considerations on the
capital structure of such an institution since the implementation of that project does not need
Lastly, almost all small companies usually have hard moments to acquire debt financing;
hence, they mostly prefer equity financing to meet the companies' business operations. Getting
debt financing for small companies, especially from banks, is a very long process. Lenders often
require a guarantee from management. In such a case, the Finance Manager will not be required
to make any decision based on the capital structure since only one source of financing is applied.
Question Four: Discuss the various modes of recent issue of IPO by Saudi Aramco
Company?
Aramco management intends to raise 5percent after the Initial Purchase Offer (IPO.
There are various modes that the company used to issue the recent IPO.
The first mode is through the public issue. This is the most commonly used method that
several companies use to issue securities to the public. Through its IPO, Aramco intends to raise
funds by listing itself on the Riyadh stock exchange for trading purposes. The second mode is
through a rights issue to existing and new shareholders. Aramco will sell 1-2 percent of its shares
to personal and institutional retail investors after the Initial Purchase Offer (IPO) to raise an
estimated amount ranging between $20 billion and $40 billion (Aljazeera, 2019).
FUNDAMENTALS OF CORPORATE FINANCE 5
Preferential Allotment
Lastly, the company also used the preferential allotment method to issue the IPO. This
method concerns the issue of shares to specific few individuals at a price that does not
necessarily match with the market price. Aramco intends to issue 1% of bonus shares for Saudi
Arabian nationals. The company aims at giving the individuals one hundred bonus shares for
every ten shares allotted to them, therefore raising an amount estimated to be 15 billion dollars
Question Five: Discuss the various factors affecting the capital structure decisions giving
appropriate examples.
There are several factors affecting capital structure decisions. These factors range from
The cost of capital is one of the factors influencing decisions on capital structure. The
company in question such as Amazon must project an earning ability to generate profit to cover
all the costs of capital and to finance Amazon's future growth. To maximize shareholders' value,
the cost of equity must be higher as compared to debts after tax. If Amazon decides to change the
structure of capital to maintain reasonable risks for both liabilities and ownership, then they will
Company Size
The size of the company is another factor affecting capital structure decisions. Small
companies, especially sole proprietorship or partnership type of companies with low capital base,
tend to rely more on equity financing (funds from the owner(s)). On the other hand, big
corporations must rely on the stock market to raise funds by issue of securities and bonds. These
FUNDAMENTALS OF CORPORATE FINANCE 6
large companies listed on the capital market, such as Aramco and Bank of America, need more
capital. Therefore, to raise enough funds, they must consider several options, and hence they
Retain Control
Additionally, retaining control is also another factor affecting capital structure decisions.
The management's attitude to maintain the power of a firm influences capital structure. In the
case where the company's current shareholders are not willing to change their holding, they will
refuse to provide additional equity shares. This will reduce the company's interest rate and
holding. The company will be unable to raise finances through equity shareholding. Thus the
only option will be through the issue of debentures and preference shares, which will be
The capital structure of a company is affected by its cash flow capacity. A company's
cash flow capability increases the financial manager's flexibility in deciding on its capital
structure. Cash produced by a company improves a company's reputation. Cash flows help the
firms to fulfill their short-term liabilities. A company will be required to pay dividends to
shareholders of equity, interest to bankers, and debenture owners. A firm's cash flow generation
capacity helps to meet this obligation. Consistent cash flows make it easier for finance managers
Interest rates
Lastly, the lending rate within the market directly affects borrowed funds. If the banker's
expectation is high, a company can withhold fund mobilization or use retention earnings. It,
References
Aljazeera. (2019). Ready, get set - Saudi Arabia approves Aramco IPO. Retrieved 28 November
listing-request-191103060527522.html
Ashri, O. (2019). On The Fast Track: Saudi Arabia's Entrepreneurship Ecosystem. Retrieved 28