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Business Finance Is Concerned With The Investment And Financing Decision Of Firms. All Investment Must Be Financed.

3784 words - 15 pages

Business FinanceIntroductionBusiness finance is concerned with the investment and financing decision of firms. All investment must be financed. Firm raise their finance in various ways; through short term and long term funds. Because resources in this world are scarce, investment involves choice and sacrifice. The firm must choose between rival projects; by choosing some it forgoes others. Since the firm is owned by shareholders, it is expected to make the decision that gives the best stream of return to them. In other words, to make the investment and financing decisions that maximizes the value of the firm.Sources of FundThere are various sources from which a business can borrow funds for its working capital needs and for its long-term expansion. Firms can get external finance for their business through a number ways including borrowing (debt), issuing ordinary shares and by issuing preference shares. The difference between these methods are significant in terms of risk, required rate of return, tax treatment, voting rights attached, and priority of repayment in the event of liquidation.Funds may be also classified as short or long term funds. Short-term funds are those, which the business has to repay within one year. These funds are usually for businesses to run their day-to-day operations including payment of wages to employees, inventory ordering and supplies. In contrast, funds, which are repayable beyond one year, are traditionally classified as long-term funds.Sources of fund include common equity (common stock and retained earnings), preferred stock, bonds, bank loans etc.Short Term FundsOverdraftAn overdraft permits a company to overdraw its account up to a maximum line of credit agreed upon with the bank. It is a convenient, flexible and there is no minimum payment amount required on overdraft. It can be drawn upon at any time and is ideal for day-to-day expenses, particularly to see through cash flow problem. However it can be an expensive way to borrow long-term, as the interest rate tends to be higher than that of a loan.The unappealing is that the interest rate charged is pegged to the bank's Prime Lending Rate. So, if the bank's PLR goes up, the interest rate at which the firm has to pay moves up proportionally. Banks lend out money to their best customers at 2% above the PLR. Therefore, if the borrower is just an ordinary customer, the interest rate charged on the overdraft account is usually PLR + 3%. Say, if the PLR of the bank is 6%, the interest rate charged is 6% + 3% = 9%.Bank loansBank loan is an amount of money that firm borrows for a set period and with an agreed repayment schedule. The repayment amount will depend on the loan size and interest rate. Loans are generally most suitable for paying for assets, like vehicle and computers, for start-up capital and other cases where the amount of money need is not going to change.The advantages are the firm is guaranteed the money for a certain period, generally three to five...

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