The Exceptional Service Grading Company requires a capital infusion of $500,000. It is currently a closely held corporation with less than 25 shareholders. Although the shareholders are not all related to each other, they all know each other, and they view the business as a family business. The financial statements are shown in an image.

Several alternatives are available to the company, consisting of the following:

• Obtain private debt financing
• Seek out a private investor(s) who would be willing to share ownership (private transfer of partial ownership)
• Seek out offers for a private buy-out (private transfer of entire ownership)
• Issue public debt (corporate bonds)
• Issue public common stock (public equity offering)

Briefly discuss each alternative and include implications to the company's capital structure and cost of capital, if any. Considering the size of the investment ($500,000 infusion), provide a conclusion on how it might impact the financial statement.

Answer:

Cost of capital: It refers to the required or needed return which is necessary to make capital budgeting projects, like building a factory, etc. worthwhile.

Capital structure: It refers to the mixture or distribution of equity and debt that makes up a firm's finances.

Step-by-step explanation

The required alternatives and their impacts are as follows:

A. Obtaining private debt financing: It will lower the firm's cost of capital, but will also enhance the firm's solvency risk. The interest payments towards debt are generally tax-deductible hence it will reduce the overall COC or cost of capital.

B. private transfer of the partial ownership: Seeking out or searching a private investor will be a dissolution of overall firm's control that means the firm's equity would be shared distributed with another individual in exchange or trade of the capital that would be very risky for the firm in case it needs to have greater control.

C. private transfer of the entire ownership: Sitting out proposals for the private buyouts indicates that selling of all the stake to another person or individual in exchange or trade of cash that would be discontinuance or stop on the business or operation on the previous owner's part, hence only when the business or firm wants or needs to get transferred or shifted to another person completely, such option need to be adopted.

D. Issuing public debt: It means decreasing the firm's overall COC or cost of capital because the payments of interest towards the debt capital are generally tax-deductible and it would help the firm in lowering its overall COC or cost of capital. It will be more prone to get more of the particular debt capital because it is produced with lowering of COC or cost of capital.

E. Issuing common stock: It means listing the firm on to the particular stock exchanges and also dilution of the control as well as ownership by raising or boosting funds through the public funding. It means that there will be more or higher equity in the firm's overall capital structure.

Impact on the financial statements:

Assuming that the firm will acquire specific stock with the imbued or infused amount i.e. $500,000, and due to this, there would be an increment in the CA or Current Assets by the amount of $500,000.

In case of the borrowing:

Due to the borrowing, the liability would also increase by $500,000.

Debt bears an interest rate. If the debt is available at 10% interest, the interest expense of the firm would be $50,000 (i.e. $500,000 * 10%). Hence the firm's interest expense would be $50,000. So, there is a reduction i.e. $50,000 in earnings before taxes in the statement of income.

In case of the issuance of common stock, the shareholders equity will also increase by $500,000.

Reference:

http://www.fundingpost.com/glossary/debtfinancing.asp#:~:text=Debt%20Financing%20means%20when%20a,and%20interest%20on%20the%20debt.