"Managing Financial Resources-6common equity is significantly higher than the cost of debt because the common equity holderstake the risk of business operations as dividends are paid out of profits only (Chandra, 2008).The principal amount of shares is also subject to market conditions because shares are traded insecondary markets and their prices fall / rise according to the expectation regarding theperformance of the company (Brigham and Joel, 2010). As stated by (Chandra, 2008), the cost ofpreferred equity lays in-between cost of debt and cost of equity because the risk of holdingpreferred stock also lays in-between the debt and equity. The payments to preferred shareholdersare fixed but their stock prices might vary because they are also traded in the secondary market. Implications of Different Sources of FinancingThere are financial and non-financial implications of each source of financing. According toChandra (2008), the debt financing has many financial impacts on the company. Firstly, the debtfinancing is cheapest source of external funding available to the company because the interestcharged is always lower than the required rate of return by both common and preferredstockholders. Secondly, the cost of debt also goes down due to the tax-shield provided on theinterest expense. As the interest expense is paid out of operating profit (EBIT) so the interestexpense reduces the taxable income due to which tax is decreased. It must also be noted that thedebt repayment and payment of interest expense is an obligation; it increases the risk of thebusiness because the interest has to be paid even if the company is in losses (Brealey et al. 2007).The debt also leads to decrease in the EPS for the company as net income is reduced due tointerest expense. The only non-financial implication associated with debt is that sometimes itrestricts the use of the assets in different areas especially in the case of secured finance. The common and preferred equity also have some financial and non-financial implications. Inaccordance to Brigham and Joel (2010), both types of equity financing lead to the higher cost offinancing to the company because the company has lower risk when it goes for equity financingas dividends are paid out of profits only. Another financial implication of equity financing is thatboth common dividends and preferred dividends are not tax-deductible as they are paid out ofafter-tax income. There are non-financial implications of equity financing as well. The equityfinancing leads to the dilution of ownership rights because the common stockholders become Managing Financial Resources-7owners of the company and they get voting rights for major decisions of the business (Chandra,2008).Appropriate Source of Financing in the Given CaseIn the given case the company needs to finance £2 Million to invest in the business and start theoperations of the business. The company has different possible combinations of debt and equityto finance the business. The company can go for all debt financing, all equity financing or a mixof debt and equity (Pan and Zhengfai, 2005). The appropriate structure recommended for thecompany is 60% debt and 40% equity. According to Ratha, Mohapatra and Plaza (2008), this isthe most commonly used mix of financing because it balances the risk and cost of financing. Inthis case the company needs to finance its working capital and capital expenditures; if thecompany finances 60% through debt financing then the company will need to raise £1.2 Millionthrough debt and £0.8 Million through equity. Since the debt is cheaper so the companies preferdebt more than equity because it will lower the weighted average cost of capital and also providetax shield to the company (Pan and Zhengfai, 2005). Another advantage of using higher amountof debt than equity is that interest expense reduces the tax of the company in the form of taxshield. Dividends are paid out of after-tax profit so they do not provide any type of tax advantage(Chandra, 2008).If the company goes for recommended mix of debt and equity then there are some disadvantagesfor the company as well. With increased debt, interest payments increase which causes thedecrease in net cash flow; due to reduced net cash flow the debt holders do not feel secure (Panand Zhengfai, 2005). Khan and Jain (2008) found that the increase in debt also causes theEarnings per Share (EPS) to go down; the decrease in EPS results in falling share price. Theshareholders also become nervous due to the fall in share prices and increasing risk of default ofthe company because the shareholders are last to be paid while redistributing the assets. Managing Financial Resources-8Task – 2Cost of each of the Suggested Sources of FinanceThere are two financing alternatives being considered by the company. The company has optedto go for either debt or equity financing; the company is not considering the mix of debt andequity. Both the debt and equity have different implications on the company considering theirrisk and return (Hale and Long, 2011). The company needs to finance a sum of £12 Million toinvest in a new project. If the company finances £12 Million by debt financing then the companyneeds to pay interest rate at a rate of 10% on the amount outstanding. It has been assumed thatthe company will be able to repay the debt in next 7 years by paying equal installments eachyear. The equity is issued at a discount rate of 15% on the current share price. The interest rate of 10% is before-tax cost of debt as interest expense in tax deductible. The aftertax cost of debt is 7.5% at the given tax rate of 25%. The total interest expense for the 7 yearswill amount to £4,602,197 whereas the after tax interest expense will amount to £3,451,647because the interest expense provides the tax shield to the company. On the other hand, thediscount given on the additional shares issued amounts to £3,240,000; the cost of issuing equitylooks lesser than the cost of debt. It must be noted that the company interest expense is paid inthe future years so their actual value can be lesser than the discount given on the additionalshares issued. It must also be noted that the dividends lead to higher cash flow for the companyas the company is expected to earn profits in this case so the overall cost of equity is higher forthe company in this case (See appendix).Information for Different Decision MakersAccording to Hale and Long (2011), the sources of finance provide different information todifferent decision makers. The financial manager gets the financial aspect of sources of financingthat how they are going to affect the financial decisions in future. The financial manager alsolooks at how each source of financing can affect the future financial statement and incorporates itin his decision making (Pan and Zhengfai, 2005). Ratha, Mohapatra and Plaza (2008) found thatthe other key decision makers of the business also look at this information to incorporate in theirdecision making. For example: the marketing manager needs to take the decision considering the Managing Financial Resources-9financials of the company; he cannot be aggressive in case of debt financing because thecompany is not able to afford decline in sales as the interest payment is an obligation and it canlead the company to bankruptcy. The sources of financing also provide information to otherdecision makers as these sources decide the amount of risk which the company can afford(Chandra, 2008).Tools Used in Financial PlanningThere are many important tools used by companies for financial planning. According to Chandra(2008), the most basic tool used in financial planning is analyzing the past financial statements ofthe company. They help in financial decision making because they show the past performanceand growth of the company. The ratio analysis is one of the most important tools used infinancial planning because it helps companies compare its performance with its own past and itscompetitors of different size. The ratio analysis is important because it calculates differentmeasures to compare the companies of different size; the companies of different sizes cannot becompared on the basis of financial statements (Brealey et al. 2007).Another important tool used in financial planning is the pro forma financial statements of thecompany. The pro forma statements are prepared on the basis of realistic assumptions and helpthe company forecast its future financing needs. The pro forma statements help managers realizethe financing needs earlier than they are actually realized (Khan and Jain, 2008). According toHale and Long (2011), the cash flow statement is more important than other statements becausethe cash flow shows the position of the cash and also helps the company realize the potentialshort-falls in near future. All these tools are important to plan future financing because thesetools indicate whether there will be a financial need in the future or not. These tools also help thecompany realize its future potential to invest in the fixed assets or other investing instruments. Impact of Each of the Sources of Finance in Income Statement and Balance SheetThe two sources of financing have been evaluated for the company. Each source of financing hasdifferent impact on the balance sheet and income statement of the company. If the company goesfor debt financing to raise the funds needed, the picture of the balance sheet will be changedtotally and balance sheet will reflect higher risk in the form of higher debt to equity ratio Managing Financial Resources-10(Girishankar, 2009). It must be noted that the company already has a significant amount of debtoutstanding so if the company goes for debt financing it will lead to increase in the risk of thecompany. It can be seen in the appendix that the company has lower cost of debt; so theadditional financing by debt results in higher earnings retained during the year. If the company goes for equity financing, the debt to equity ratio of the company will bedecreased which indicates the lower risk of the company (Brigham and Joel, 2010). It can beseen in the appendix that the net current assets of the company remain same in the both casesbecause the company finances same amount by either source of finance. It has been calculatedthat the required rate of return on equity is significantly higher than the cost of debt which leadsto higher dividends by the company. Though the equity financing will lead to higher net incomebut the retained earnings for the year will be lesser due to higher dividends than interest expense.Task – 3Analysis of Cash BudgetAs per the statement of Mu (2006), the cash budget refers to the estimation of the individual orthe company’s cash inputs and outputs over a certain time period. These cash budgets helps thecompanies to develop and generate the summary of the predicted revenues, the operatingexpenditures incurred by the company, the purchases of the company’s assets, sale of thecompany’s assets and this tool also facilitates the financial managers in determining thecompany’s need for cash and the situation when the company has cash in abundance. In the lightof the above mentioned cash budget it can be observed that the company’s opening balance ofcash is increasing since the month of February but in the month of April this opening balance hasshown some decline. This decline in the opening balance is might be due to the increase in theexpenses of the retail store or might be due to the increase in the payment of the expenses.Furthermore it can also be seen through the cash budget of this retail store that the company’scash inflows are increasing despite of the credit purchases that the company has made. In orderto make the cash budget of the company more attractive and better the store must take measuresthat incorporate the comparison of the predicted revenues, sales and expenses with the actualreport. "