Introduction to Finance

Prepared By:
Dr. H. M. Mosarof Hossain
Professor
Department of Finance
University of Dhaka
mosarof@du.ac.bd

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 Chapter Five: Long Term Financing

Definition:
Required amount of fund collected by a business enterprise
for meeting up fund requirement for acquiring important
useable items from which there is long term benefit
expectation and making investment for earning expected
return over long period of time from different available
sources for more than 7/10/15 years time period is known as
long term financing.

Features of long term financing:

Longer maturity Larger size of loan
Users of loan use of fund in capital machineries
Sources Repayment method
Security lesser cost of financing 2
 Sources of Long Term Financing

(a) Internal sources- promoter’s initial capital, retained

earnings, general reserve, dividend equalization fund,
sinking fund, workmen’s compensation and welfare
fund.
(b) External sources- common share capital, preferred
share capital, bond/debenture, commercial bank loan,
loans from nonbank financial institutions, loans from
specialized financial institutions and leasing.

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 Cost of long Term Financing
(A) Cost of internal sources of financing i.e.
opportunity cost:
(i) Constant amount of dividend forever :K=D0/P0
(ii) Constant growth of dividend forever :K=(D1/P0)+g
(B) Cost of external sources of financing:
(i) Cost of common stock financing:
(a) Ke = D0 / P0; Constant amount of dividend and no floatation cost
(b) Ke = D0 / P0 (1-f); Constant amount of dividend and % form of
floatation cost
(c) Ke=D0 /(P0-F); Constant amount of dividend and amount form
of floatation cost
(d) Ke = [D1/ (P0-F)] + g; Constant growth rate of dividend and
amount form of floatation cost
(e) Ke = [D1/ P0 (1-f)] + g; Constant growth rate of dividend and %
form of floatation cost
* Ke = Rf + (Rm - Rf)β (according to CAPM approach)
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 Cost of Long Term Financing
(ii) Cost of preferred stock financing:
(a) Kp = Dp / Po (1-f); % form of floatation cost is given
(b) Kp = Dp / (Po-F); amount form of floatation cost is given

(iii) Cost of debt financing:

(a) Kd = [Kb (1-T)] / (1-f); % form of floatation cost, borrowing
rate and tax rate are given
(b) Kd = I (1- T) / Po (1-f); Amount form of interest and % form
of floatation cost and tax rate are given
(c) Kd = I (1-T) / (Po-F); Amount form of interest and floatation
cost and tax rate are given

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 Cost of Long Term Financing
Scan Cement Ltd is currently paying Tk.15 dividend on its
common stock and is expected to grow @ 4.5% forever. The
current market price per share is Tk.65 of its Tk.100 par value
and it has 100000 shares in the market. For issuing new
shares it will have to pay 3% commission to underwriters. It is
paying preferred dividend Tk.10 per share of its Tk.95 per
share that's par value is Tk.100 and it has 50000 preferred
shares in the market. The related issuing cost is Tk.2.5 per
share. It has also Tk. 1000000 long-term bank loan @ 12%
interest rate. The corporate tax rate in the country is 35%.
There is 1.5% loan agreement cost for the company. Retained
earnings balance is Tk.500000. Which source of financing is
recommended for the company?