Sources of Corporate Finance
The exam tests whether you can classify a source of finance correctly and choose it using cost, risk, control and obligation.
Owned capital
- Equity shares: permanent capital, voting rights, dividend only when declared, residual claim on assets.
- Preference shares: fixed rate, priority over equity for dividend and repayment, normally no voting, arrears accumulate if cumulative.
- Retained earnings: internal, no issue cost, limited by profits and dividend policy.
Borrowed capital
- Debentures (Sec 71): creditor status, interest payable whether or not the company earns profit, usually secured.
- Public deposits: Companies (Acceptance of Deposits) Rules 2014 allow up to 35% of paid-up capital plus free reserves and securities premium, with a 10% sub-limit for members and directors; tenure 6 to 36 months.
- Bank and institutional term loans, trade credit, leasing, and foreign sources such as GDRs, ADRs and ECBs.
Worked example
A firm has EBIT of ₹20 crore and existing interest of ₹6 crore. It needs ₹40 crore and can raise it as 10% debentures or as equity. With debentures, interest becomes ₹10 crore, so interest coverage is 20 ÷ 10 = 2. If EBIT falls 30% to ₹14 crore, coverage falls to 1.4, which is thin. With equity, coverage stays at 3.33 but ₹40 crore of fresh shares dilute control and EPS. The exam expects this trade-off, not just the tax saving.
Traps
- Saying debenture interest is paid out of profit - it is a charge against profit.
- Treating trade credit as long-term capital.
- Forgetting that public deposits beyond the 35% and 10% limits are not permitted.