THE FINANCING DECISION BASIC INFORMATION AND TUTORIALS

The financial manager’s second responsibility is to raise the money to pay for the investment in real assets. This is the financing decision. When a company needs financing, it can invite investors to put up cash in return for a share of profits or it can promise investors a series of fixed payments.

In the first case, the investor receives newly issued shares of stock and becomes a shareholder, a part owner of the firm. In the second, the investor becomes a lender who must one day be repaid.

The choice of the longterm financing mix is often called the capital structure decision, since capital refers to the firm’s sources of long-term financing, and the markets for long-term financing are called capital markets.

Within the basic distinction—issuing new shares of stock versus borrowing money —there are endless variations. Suppose the company decides to borrow. Should it go to capital markets for long-term debt financing or should it borrow from a bank?

Should it borrow in Paris, receiving and promising to repay euros, or should it borrow dollars in New York? Should it demand the right to pay off the debt early if future interest rates fall?

The decision to invest in a new factory or to issue new shares of stock has long-term consequences. But the financial manager is also involved in some important short-term decisions.

For example, she needs to make sure that the company has enough cash on hand to pay next week’s bills and that any spare cash is put to work to earn interest. Such short-term financial decisions involve both investment (how to invest spare cash) and financing (how to raise cash to meet a short-term need).

Businesses are inherently risky, but the financial manager needs to ensure that risks are managed. For example, the manager will want to be certain that the firm cannot be wiped out by a sudden rise in oil prices or a fall in the value of the dollar.

We will look at the techniques that managers use to explore the future and some of the ways that the firm can be protected against nasty surprises.

footnotes:

*Accountants may treat investments in R&D differently than investments in plant and equipment. But it is clear that both investments are creating real assets, whether those assets are physical capital or know how; both investments are essential capital budgeting activities.

5 Money markets are used for short-term financing.

CAPITAL STRUCTURE - Firm’s mix of long-term financing.

CAPITAL MARKETS - Markets for long-term financing.