Identify the different sources of finance available to Mr Norman for buying the new online learning system to expand his service business. There are many different sources of finance available to Mr Norman for investment in order to expand his business. These include: Using personal savings to invest in the business growth
Raising equity through issue of new shares.
Short term bank loan
Long term bank loan
Using retained earnings from the profits earned in the past
Issuing loan notes
Analyse the cost of different sources of finance and explain what the likely implications are of the various sources of finances that you identified in preparing the task above. Using personal saving to invest in the business growth means that Mr Norman will be using his own money to buy the new online learning system. There is no real cost of this source of finance. However, there is an opportunity cost of this investment that is the interest that the money will earn if it is left in the bank (or any other income that it could generate if it is not invested in the business). However, it is to be noted that Mr Norman wants to keep his expenses to the minimum therefore this may not be an appropriate source of finance in this scenario. Raising equity through issue of new shares mean that Mr Norman will be issuing new shares for his company to people other than himself. Equity is a high risk investment and consequently the cost of equity is also very high as compared to the debt finance. The new shareholder will not only take away a share of the profits but issuing new shares will also dilute the control of the business. Short term bank loans are a very good source of finance. The cost is relatively lower than the equity finance and unlike the equity finance the principal amount is redeemable after some time and is not perpetual. Mr Norman may be able to get a short term bank loan in order to finance the purchase of the new online learning system. Like the short term bank loan, a longer term bank loan may also be used to finance the purchase of the new online learning system. The rate of interest charged for the longer term loans is usually lower than the rate for shorter term loans. However, the total cost of finance becomes higher because of the longer period of borrowing. The long term bank loans are best if the organisations want to invest in a long term project and want to pay back the loan in instalments of relatively smaller amounts. Bank overdrafts are also a very good source of finance available to the businesses. Overdrafts are very flexible as the organisations can borrow the exact amount that they need to borrow from the bank and for the exact period of time that it is needed. However, the higher level of flexibility means that the cost is very high. This means that these are only appropriate for supporting the day-to-day operations of the business. Using the retained earnings from the profits earned in the past is similar to Mr Norman investing from his personal savings. There is no dilution of control and no actual cost, and the opportunity cost is the only cost in this case as well. The difference is that the retained earnings are the savings that have already been separately kept for re-investment into the business. Issuing loan notes is also an option for the company to raise new finance. The company can issue loan notes at their own terms and conditions such as the redemption period and the interest rate. The only problem with the loan notes is that the company cannot be certain as to whether the loan notes will be taken and how long it would take the company to raise the required amount. Some financial institutes also offer leaseback options. Mr Norman can sell one or more of the company assets to a financial institute and then lease the asset back from the institute. This will raise sufficient funds to finance the purchase the new online learning system. Another option would be...
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