Sources of

funding

Equity Debt

Stated Reserves-
Equipment Mortgage
Capital- Capital and Preference Sell and
Term loans loans and Debentures backed
Share Revnue Shares lease back
leases loans
Capital Reserves
Sources of Finance

Sell and Lease back scenario: A company having a land in a prime area and which is
currently undergoing liquidity issues can sell it and lease it back. The lease needs to be paid
off to have back the ownership.

Equity Funding

1. Initial Public Offering- IPO: When shares are first offered to the general public.
2. Rights Issue: These are sold at a lower price than the present market price and issued to
existing shareholders. But the issue price is at a higher value than the nominal value.
3. Bonus Issue: Also known as scrip issues and issued free of charge. Bonus issues are given
in lieu of dividends. The existing SHs can sell these bonus shares in the market to make
more money.

Institutional Investors

1. Pension Funds- EPF, ETF

2. Insurance companies
3. Unit Trusts-Units are instruments which are also instruments tradable at the stock exchange.
But they have fewer risks and fewer returns. Units are part of a fund. The entire fund is then
invested in diverse businesses. Even if share prices fluctuate drastically, such major
changes are not reflected in units. Neither severe price increase nor drastic drops.

Venture Capitals

Centred more with HNWI (High Networked Individuals-Dhammika Perera etc.) These
HNWIs who have huge amounts of money invest in high risk and high return, young
businesses which turn out be IT firms more often. They prefer a board seat to ensure good
governance in those organisations. They buy ordinary shares and the funds are in the form
of equity. Pressure the company to perform well and exits when the investee company goes
public and thus to sell their investment at that time.

Cost of Capital

Cost of Capital can be defined as the minimum acceptable return on an investment, which is
also known as the hurdle rate.

Average cost of funds <= Average return from the investments

Cost of Equity- Listed Companies

1. Gordons Dividend Growth Model

ke= ( dp 10100 )+ g
ke = Cost (k) of Equity

d1= Dividends in Y1

p0= Price of Share in Y0

(d 1d 0)
g= Growth rate in dividends: 100
d0

2. Capital Asset Pricing Model (CAPM)

ke=Rf + ( RmRf )

ke = Cost (k) of Equity

Rf= Risk free Return-(Zero risk, Return from Treasury Bills) (12-month rate)
 Rm=Market Return

= Beeta factor (risk factor)

If, =1.2, then that business is 20% more riskier than the market

= 2.4, then the business is 140% more riskier than the market

ke
y= ke
Acceptable Security
Businesses Market Line x=

m= (Rm-Rf)

c= Rf
Unacceptable
Rf Businesses

Cost of Equity- for Unlisted Companies

Estimate the ke of similar listed companies and then add a further risk premium for financial
and business risk.
The risk free rate should be amended with the addition of estimated risk premiums for both
the business risk and financial risk for the entity.

Cost of Debt Capital

Bank loan: kd=i(1t)

Debentures:
Types of COC

Cost of Equity: Cost of Ordinary shares and reserves. Only used if the company is funded
100% by equity.
Weighted Average Cost of Capital-WACC: This is the most widely used measure to
determine the cost of capital and uses an average cost of the total mix of capital.
Marginal Cost of Capital-MCC: The incremental cost figure between the new capital
structure and old capital structure.