Financial Options Paper

Topics: Corporate finance, Finance, Internal rate of return Pages: 12 (4619 words) Published: January 21, 2007
Running head: Financing Option Paper

Financing Option Paper

This paper discusses various methods available to organizations when seeking financing for special projects, namely a Casino / Resort hotel complex with a projected budget of $600M. The various methods described include the analysis of capital valuations modeling with respect to the cost of various debt and equity measurements available. Long-term finance alternatives are presented, as are the different sources of capital available to organizations. The paper concludes with a look at various cash management techniques needed by the Casino / Resort for operating as well as the various methods of short-term financing. Capital Valuation Models

Capital modeling provides common metrics for risk and reward analysis that can be used to compare the risk-adjusted profitability and the relative cost of capital for a wide range of capital sources. Modeling capital allows one to evaluate the overall capital adequacy in relation to the risk tolerances and profile of your business segments. To properly analyze risk, management needs to consider how they will determine and fund an adequate level of economic capital for a business venture, such as a Casino / Resort hotel complex. There is a need to develop an economic valuation methodology and model that is consistent and comprehensive. The intent of this capital analysis is to assist with performance assessment and decision-making. You will need to develop scenarios focusing on various sources of capital you intend to pursue. It is necessary to calculate both the weighted average returns of your capital scenarios, and the expected rate of return your investors will demand for the individual debt and equity instruments you are considering as capital sources. One model that should be considered is the Capital Asset Pricing Model (CAPM). It is a formula based set of calculations used to model expected returns for equity. The general concept behind CAPM is that investors require compensation for both the time value of money and the risk incurred. The time value of money is represented by the risk-free rate and compensates investors for placing money in your company time. Components of the formula represent risk, and calculate the amount of compensation the investor needs for taking on additional risk. The model uses a risk measure, called beta, which compares the returns of your assets, to the market over time and to the market premium. The model allows you to calculate the expected return on a risk-free security plus a risk premium. If this expected return does not meet the required return then you will not be able to attract capital, and that component of your project is not viable. The model is only as effective as the validity of the data you input with respect to the calculations.

Another model to be considered is the Dividend Discount Model (DDM). This model is another tool for equity valuation. Here, the financial theory states that the value of stock is the worth all the future cash flows expected to be generated, discounted by an appropriate risk-adjusted rate. Dividends are used as a measure of cash flows returned to the shareholder.

These models depend on the validity of the assumptions that are made, and how they are applied to the model being used. For example, DDM is highly sensitive to the assumptions made about growth rates and discount rates. You may need to conduct sensitivity analysis to establish an appropriate result. Keep in mind that these models are a good starting point to begin thinking about the valuation of your sources of capital, but should be used in conjunction with sound business fundamental analysis. What is beneficial in using the models is that it forces you, as future resort owners, to begin thinking about different scenarios in relation to how the market is pricing capital.

These models should be considered to assist with your...

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