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In order to fully understand the matter at hand, it will be wise to first provide a definition of the term “external financing”. Over the years, there has been a need to expound further on the definition of the term “external financing”, and many authors have come up with different definitions. In simple terms, external financing basically refers to any form of financing that is acquired through sources other than those present in the company itself (Rudman,1999). This basically means that the finances are to be obtained from external sources that are completely independent of the company. External mode of financing projects in a company essentially provides for additional capital, thus it acts as a supplement to the already existing working capital.
Basically, there are two well-known forms of external financing. These forms are either debt or equity finances. In debt financing, Acme will be forced to take up a bank loan through issuance of debentures. This bank loan is to be paid off by the company within a stipulated time frame. When the company agrees to enter into a loan agreement with a bank, it also accepts the liability of paying an interest rate as agreed upon. Equity financing, on the other hand, refers to the company obtaining funds by way of selling part of their ownership to either a private entity or a public forum. The steps taken in achieving this involve Acme selling its stock through investment bankers or venture stockbrokers.
There are also other forms of external financing which include: leasing which refers to a business agreement that allows two business parties to commit themselves to an agreement that involves renting an asset facility and then paying a monthly rent on the same premise, or rather asset. This form of financing is advisable for projects that are intended to run for a short period of time since, since it will be expensive to obtain financing through leasing with businesses that are intended for long term. Hire purchase is another form of external financing, and in this form of financing, the company will have to hire the asset facility for a stipulated period of time, while making fixed habitual payments. And when the agreed time expires, the company will then fully own these asset facility. In debt factoring form of external financing, the business sells its outstanding client debts to a company which deals with debt factoring. For instance, Acme may consider selling the accounts of the defaulting clients to an external debt factoring company, so that the company in turn pays Acme a substantial amount of money for the given debts but at lower percentages (Snell, 2003). As much as these three are considered external sources of finances, in this assignment only debt and equity will be dealt with in detail. This is because the amount to be raised by the company is relatively high; hence, it will be completely illogical to depend on these lesser forms of external financing.
The advantages related to external financing include a substantially faster growth of the business. For instance, Acme is in dire need of expanding its activities into a foreign market, and will thus not only depend solely on its profits for the expansion of business. In fact, it is wise for the company to use the assets it possess as security when acquiring funds, especially debt financing. Secondly, it is only with external sources of funds that the company will be able to reach vast economies of scale. These economies of scale are meant to equip the company with right materials against their competitors. This is made possible due to Acme being a multi-billion company which possesses greater bargaining power with its suppliers than its smaller counterparts in the industry. The last but not the least advantage of external financing is a substantial amount received by the business as leverage returns. Leverage return is basically achieved when the company does not use its own source of funds but rather manages to acquire funds for itself due its dealings with borrowed money (Peters & Waterman, 2002).
The disadvantages attributed to external sources of financing include a loss of ownership, especially when equity financing is involved. The major effect of this mode of finance is that there will be a decrease in control of Acme over its operation in the foreign market. It is also somehow illogical to give up a vast amount of shares, thus overlooking the possibility of future profits from the same shares. The major setback in debt financing lies in its interest costs that are usually associated with paying off the loan to the lender. When debt financing becomes the only available option of external financing, Acme as a company may be forced to accept high interest rates. In equity financing, the profits may be reduced substantially due to the fact that investors expect to be paid dividends on each and every share of the company they hold.
A setback experienced by both forms of financing lies with the cash flow of the working capital. In the case of debt financing, working capital may be reduced to pay both the principal and interest of the loan acquired, while in equity financing the working capital is reduced, especially when dividends are paid to the shareholders (Yescombe, 2002).
I recommend that Acme as a company embark on combining both sources of external finances. It can do this by distributing the amount into equal percentages so that the amount is partly raised using equity as a form of financing, and partly use debt financing so that in the long run efficiency and effectiveness is reached. Since the project is expected to be established in a foreign land, it will be wise for Acme to get the locals involved by making its shares available to the foreign public, so as to create a conducive environment for the growth of the firm. On the other hand, it should take into account the fact that it has the mandate of controlling the entire operations of the business, and thus supplement the finance by debt. As in the case with debt financing, the company will still hold a rather substantial percentage of the shares, and thus be in control.