Debt vs Equity Financing

1295 Words Nov 19th, 2011 6 Pages
Midterm Project
FIN 4873

Debt vs. Equity Financing

Your consulting team has been to hired evaluate the financing of a new project. The company wants to fund the project with either debt by borrowing the money or equity by selling additional common stock. The company does not want a combination of debt and equity financing, nor do they want any exotic financing such as convertibles, debentures, warrants or bonds. It’s simply debt versus equity. The company’s CFO (me) and Board of Directors (rest of class) will listen to your presentation and ask you questions concerning your recommendation. By the way, you are the consultant, so do not recommend hiring another consultant.

Assumptions and Considerations:

• Company: Each
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The easiest way to determine free cash flows is to take the difference in cash flows from the Base Case scenario and that of the Project Case, as we will do in the classroom. • Step 5: Assuming that the decision has been made to fund the project, then you will want to build in the financing under the debt vs. equity scenarios (one model for each). • Step 6: You will now want to consider the impact of each form of financing on the firm. How does the form of financing impact the company’s debt ratios, EPS, ROE, etc.?

You will also want to check the reasonableness of your projections: for example, using the DuPont Identity (Net Profit Margin*Total Asset Turnover*EquityMultiplier = ROE) on the historic company statements and the proforma statements. This test should show if the project projections are within reason. For example, if the TA Turnover of the historic data is 1.0 times, meaning $1 in sales for every $1 in assets, and the proforma cash flows’ TA Turnover is 4.0 times, meaning $4 in sales for every $1 in assets, then there is probably an unreasonable assumption that has been made unless new factors can satisfactorily explain the difference.

Other considerations: • Charts and graphs will be helpful to explain the decision. • Your team needs a written report of at least three pages, but whatever is necessary to adequately
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