Question

Provide a real life example of a long-term external source of finance used by a listed company in Hong Kong. Describe the nature of this financial arrangement (e.g. purpose, duration, risk assessment, etc.). In your opinion, explain whether this financial arrangement was a right move and suggest alternatives to this arrangement with reference to what you learned in this course and provide justifications.

Answer 1

First of all, External source of finance means obtaining funds that come from outside an organization. External source include both long term as well as short term sources.

Long term sources includes-

• Equity shares
• Debenures
• Preferred stock
• Venture Capital
• Leasing  

Example of CK Hutchison Holding Limited

CK Hutchison Holding limited is a listed company in Hong Kong. Following are the examples of a long term exernal source of finance used by this company in year 2018 :

1. Ordinary Shares
2. Preference Shares

Nature of these arrangemnet

1. Ordinary Shares

Ordinary Shares also known as Equity Shares. The main purpose of this is to raise funds through owner's capital.

Because of following purpose, company motivates to raise them :

• Equity shareholdres re paid on the basis of earning of the company and do not get a fixed dividend. They receive what is left after all oter claims on the compny's income and assests have been settled. So, it stands last in the list of claims.
• It provides cteditworthiness to the company and confidence to prospective laon providers.
• There is no burden on the company, as payment of dividend is not compulsory.
• Equity issuse raises funds without creating any charge on the assets of the company.

Equity shares are the form of fractional or part ownership in which the shareholder, as a fractional owner, takes the maximum business risk.

Following are the risk or limitations of ordinary shares:

• Investors who prefer steady income may not prefer these shares.
• The cost of equity shares is higher than the cost of raising funds through other sources.
• The issue of additional quity shares dilutes the voting power and earnings of existing equity shareholders.
• Many formalities and procedural delays are involved and they are time consuming processes.

2. Preference Shares

Following are the main purposes or reasons why company prefer these type of shares:

• It does not affect the control of quity shareholders over the management as preference shareholders don't have voting rights.
• Payment of fixed rate of dividend to preference shares may make a company to announce higher rates of dividend for the equity shareholders in good times.
• Also, they are have reasonably steady income in the form of fixed rate of return and safety of the investement.
• Preference Capital does not create any sort of charge against the assests of a company.

Following are the risk or limitations of these shares:

• The rate of dividend on preference shares is generally higher than the rate of interest on debenture.
• Preference capital dilues the claims of equity shareholders over assests of the company.
• The dividend paid is not deductible from profits as an expense.so, there is no tax saving.

Duration

Preference shares that can be converted into equity shares within a specifiied period of time are known as convertible preference shares. Non-convertible shares are such that can not be converted into equity shares. Intervals say six months or one year.

Opinion and suggestion for alternatives: (with justification)

Although, This financial arrangement by company was a right move, debentures are a good alternatives this arrangement because-

• This a very cheap source of finance than other sources. So, it is economical sources.
• There is non-interference in the management also as thay have no control and voting rights.
• They can enforces the security by sale in case of default.