MATHEMATICS AND ECONOMICS

 TO DO a. Discuss the pros and cons of option 1, and prioritize your thoughts. What are the most positive aspects of this option, and what are the biggest drawbacks? b. Do the same for option 2. c. Which option do you think Sara should recommend to the board and why?  

Question 1 Answer

In order to expand a business, it is necessary for the owners to source for financial resources. Therefore the available resources that can be tapped are divided into two; acquisition of debt and obtaining equity finance. Debt financing will involve obtaining a loan which is repaid plus an interest while equity financing may involve selling a firm’s interests like floating of shares. If Merit decides to use JPMorgan Chase bank to borrow the $4billion in loan and an additional $2 billion, there are advantages and disadvantages accrued to it. The most positive aspect in debt financing is that, it does not temper with the ownership interests of the firm. Merit can remain private and independent. Besides, JPMorgan Chase bank will have no entitlement to future profits of the firm. The bank will only be entitled to repayment of the agreed –upon principal and interest of the loan. Moreover, the principal and interest obligation are normally constant, hence can be planned for except in an incidence where a variable rate has been used. There are no complications in obtaining debt financing since Merit is not expected to conform to various legal regulations or requirement. Merit will also not be required to send mails to a big number of investors and hold regular meetings in order to make certain decisions. Furthermore, Merit can use its tax returns to pay the interests hence reducing the cost of the debt.

However, the major drawback of this option is that debts must be repaid at some point. The numerous installments in interest paid may be too much for Merit; to an extent if it defaults there are grave repercussions which might render the firm bankrupt. Acquiring such a huge debt of $4billion and an additional $2billion of which it will be restricted for the firm is quite demanding. This also limits the growth of the firm as a result of servicing the loan. Besides, cash flows for making interest payment must be planned for which limits the use of the funds for other purposes. Merit might also face restrictions on some ventures that may be profitable but risky, which the bank might consider from the statements as a threat to their funds. In debt financing Merit will be required to pledge assets as collateral for the loan guaranteeing repayment of the loan.

Question 2 Answer

Under option 2 Merit is considering making an initial public offer by floating shares in the market. Through such measures, the company’s major benefit will be, it will not be required to repay the money, indeed it might recover through profits realized out of the investments. In case high profile investors venture into the shares, the firm will be guaranteed of higher business credibility. In most cases the investors will not demand their money to be paid back in an incidence of loss making, since they understand the riskiness involved in venturing into the business hence possibility of Merit running bankrupt.

The main drawbacks in such kind of financing are the dilution of ownership. The firm is no longer independent as it has to incorporate the decisions of investors through numerous meetings. This may be costly and tedious to the firm. As a matter of fact, Merit will be required to act in the interest of the shareholders hence needed to disclose various statements of finance to ascertain its performance of which Merit is not used to.

Question 3 Answer

Though the firm is not used to equity financing Sara should recommend it to the firm to avoid situations of running bankrupt. With debt financing the firm is not assured of making full repayment, of which JP Morgan and its affiliate banks might recall the debts to be paid fully before time. This might put the firm’s finances in a serious fix. Besides, the firm has already a good reputational background which implies floating an initial public offer will be more profitable and less restrictive. Therefore this will be the best decision of financing the expansion strategies. Though investors will want to participate in any stock Merit is offering, the end result will be far better of.

 

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