44 Sources Of Funds

Capital investing requires a source of funds. For large companies multiple sources may be employed.

The process of obtaining funds for capital investment is called financing. There are two broad sources of financial funding; debt financing and equity financing. Debt financing involves borrowing and utilizing money which is to be repaid at a later point in time. Interest is paid to the lending party for the privilege of using the money. Debt financing does not create an ownership position for the lender within the borrowing organization. The borrower is simply obligated to repay the borrowed funds plus accrued interest according to a repayment schedule. Car loans and mortgage loans are two examples of this type of financing. The two primary sources of debt capital are loans and bonds. The cost of capital associated with debt financing is relatively easy to calculate since interest rates and repayment schedules are usually clearly documented in the legal instruments controlling the financing arrangements. An added benefit to debt financing under current U.S. tax law (as of April 2000) is that the interest payments made by corporations on debt capital are tax deductible. This effectively lowers the cost of debt financing since for debt financing with deductible interest payments, the after-tax cost of capital is given by:

Cost of CapitalAFTERTAX = Cost of CapitalBEFORETAX * (1 " TaxRate) where the tax rate is determine by applicable tax law.

The second broad source of funding is equity financing. Under equity financing the lender acquires an ownership (or equity) position within the borrower's organization. As a result of this ownership position, the lender has the right to participate in the financial success of the organization as a whole. The two primary sources of equity financing are stocks and retained earnings. The cost of capital associated with shares of stock is much debated within the financial community. A detailed presentation of the issues and approaches is beyond the

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