Financing Decision

The investment decision is the first principal decision a corporation has to take. The second is Financing decision which means how to raise money for this investment. A corporation can raise money from:

  1. Lenders, and
  2. Shareholders

A. Borrowing Money from Lenders
A corporation can borrow money from:

  1. Banks

    A corporation can borrow money from a bank, where the corporation has to repay the cash back plus a fixed rate of interest for the use of capital.

  2. Issuing Bonds

    A corporation can also borrow by issuing bonds. In this case, the corporation also has to repay the cash back plus a fixed rate of interest for the use of capital.

The corporations often pay interest rate to bond holders less than the interest rate they have to pay to the banks. However, it is very difficult for young corporations to sell their bonds. So, usually they have to rely on bank loans.

B. Shareholders
Corporations can raise money either by:

  1. Reinvesting the cash flow in the shape profits. In this case the corporation is investing on behalf of existing shareholders.

  2. Issuing new shares. The investors who buy new shares contribute cash in exchange for a fraction of the corporation's future cash flow and profits.

In both the cases the shareholders are equity investors, who contribute equity financing.

RELATED PAGES
- Definition: Corporate Finance
- An Overview of Corporate Finance


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