Black & White Ltd produces a range of central heating systems for sale to builders' merchants. Because of increasing demand for the business's products, the directors have decided to expand production. The cost of acquiring new plant and machinery and the increase in working capital requirements are planned to be financed by a mixture of long-term and short-term borrowing. Required:

(a) Discuss the major factors that should be taken into account when deciding on the appropriate mix of long-term and short-term borrowing necessary to finance the expansion programme.

(b) Discuss the major factors that a lender should take into account when deciding whether to grant a long-term loan to the business. 

Answser:

a) following factors to be considered for appropriate mix of long term borrowing and short term borrowing for expansion programme

i) Nature of expenditure: If amount is required for capital expenditure purpose and there will be huge amount blocked in that . it can be done by long term borrowing via shares, debentures. if amount is for working capital requirement,it can be met by hedging of financial instruments, Inventory ,accounts receivable etc.

ii) Periodicity of borrowing: If the borrowing is to be done in several installments to fulfill projct. It is suited for long term borrowing or else it will be short term borrowing.

iii) Rate of interest/ Cost of capital : Now a days Banks interest rate are depends on federal banks lending rates as well as banks internal cost of funds and there is paucity of data how it differs, it makes difficult to go for short term or long term borrowing.based on the experience one can choose which type of borrowing is suitable .

iv) Business policy on retained profits : If the management objective is to investment of retained profits at a rate more than Internal rate of return, then it is advisable for long term borrowings if not management can opt for short term borrowings by which they can use the funds for transfer of profits for settlements of dues and they can try to get new borrowings at economical way.  

v)Business contunity: For a start up it is very difficult to get long term borrowings as there is no certainity of continuing business and there is less scope to make  viable projections.

vi) income and life of the project: Income and life plays an important role in selection of long term or shoet term borrowings .

b) Lender has to consider following points to grant a long term loan to the business.

i) Nature & details of project: lender has to observe project documentation and details of it.

ii) credibility of borrower: lender has to ascertain borrower repay capacity and finance position of the borrower.

iii)lending rate: lendor needs to ascertain cost of funds for financing this loan and recovery of overhead for this particular project.