Finance for Multinational Financing a Thesis

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S. Legal, 2008). This is primarily due to the fact that unlike equity issues, they do not dilute shareholder's equity or suppress share price. Debt issues are typically conducted with financial institutions only, rather than the markets. However, debt issues have several disadvantages. Debt is an obligation that must be paid. The obligation is both short-term (interest payments) and long-term (principle repayment). However, the payment of this obligation is tax-deductible, as it is in classified as an operating expense. This means that debt has an inherent tax advantage (Richards, no date), one of the main reasons why the cost of debt is typically lower than the cost of equity. There are other disadvantages to debt as well. Debt issues typically require collateral and/or restrictive covenants. For a greenfield investment, the firm would have to post existing fixed assets as collateral, not the new factory. Any restrictive covenants can impact management's ability to run the company as they see fit.

There is a third financing option, mezzanine, but this is of limited appeal to our firm and is typically geared towards entrepreneurs. This form of financing is essentially debt without collateral. Very high interest rates are used by the lender to manage the risk. This is not appropriate for firms with better, less costly, financing options available to them.

When considering whether to issue debt or equity in order to finance this venture, we must consider the firm's financial position in terms of both liquidity and capital structure. We must also consider how best to match the inflows from the project with the outflows for servicing the project.

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Other factors should also be considered, such as the current interest rates and the expected direction of future interest rates.

It is also worth considering that the project, being greenfield, is going to take at least a couple of years to start to generate revenues. Ideally, the choice of financing will defer the financing costs until they can be paid for with the revenues from the plant. With any option, there will be upfront costs. A debt issue, however, will allow for the plant to pay for future interest costs. The longer the term of the bond or debenture the greater the chance that the factory itself will pay for the principle repayment.

It is recommended that the plant be financed with long-term debt in the form of a debenture issue. The first reason is that because as a greenfield, the project has relatively high risk. Thus, the variability of the expected returns is high. The lowest cost of capital should be used in order to increase the likelihood that the project is profitable. Moreover, debt financing brings the time frame of the financing cost in line with the time frame of the project. A debenture, for example, will have the vast majority of the debt costs paid by the revenues generated from the facility, despite the long time frame until the facility generates revenue. Lastly, the dilutive effects of an equity issue would not be viewed favorably by our shareholders, in particular given the relatively risky nature of the project.

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