Financial Options Paper

Running head: Financing Option Paper

Financing Option Paper

Introduction

This paper discusses various methods available to organizations when seeking financing for special projects, namely a Casino / Resort hotel complex with a projected budget of $600M. The various methods described include the analysis of capital valuations modeling with respect to the cost of various debt and equity measurements available. Long-term finance alternatives are presented, as are the different sources of capital available to organizations. The paper concludes with a look at various cash management techniques needed by the Casino / Resort for operating as well as the various methods of short-term financing.

Capital Valuation Models

Capital modeling provides common metrics for risk and reward analysis that can be used to compare the risk-adjusted profitability and the relative cost of capital for a wide range of capital sources. Modeling capital allows one to evaluate the overall capital adequacy in relation to the risk tolerances and profile of your business segments. To properly analyze risk, management needs to consider how they will determine and fund an adequate level of economic capital for a business venture, such as a Casino / Resort hotel complex. There is a need to develop an economic valuation methodology and model that is consistent and comprehensive.

The intent of this capital analysis is to assist with performance assessment and decision-making. You will need to develop scenarios focusing on various sources of capital you intend to pursue. It is necessary to calculate both the weighted average returns of your capital scenarios, and the expected rate of return your investors will demand for the individual debt and equity instruments you are considering as capital sources.

One model that should be considered is the Capital Asset Pricing Model (CAPM). It is a formula based set of calculations used to model expected returns for equity. The general concept behind CAPM is that investors require compensation for both the time value of money and the risk incurred. The time value of money is represented by the risk-free rate and compensates investors for placing money in your company time. Components of the formula represent risk, and calculate the amount of compensation the investor needs for taking on additional risk. The model uses a risk measure, called beta, which compares the returns of your assets, to the market over time and to the market premium. The model allows you to calculate the expected return on a risk-free security plus a risk premium. If this expected return does not meet the required return then you will not be able to attract capital, and that component of your project is not viable. The model is only as effective as the validity of the data you input with respect to the calculations.

Another model to be considered is the Dividend Discount Model (DDM).

This model is another tool for equity valuation. Here, the financial theory states that the value of stock is the worth all the future cash flows expected to be generated, discounted by an appropriate risk-adjusted rate. Dividends are used as a measure of cash flows returned to the shareholder.

These models depend on the validity of the assumptions that are made, and how they are applied to the model being used. For example, DDM is highly sensitive to the assumptions made about growth rates and discount rates. You may need to conduct sensitivity analysis to establish an appropriate result. Keep in mind that these models are a good starting point to begin thinking about the valuation of your sources of capital, but should be used in conjunction with sound business fundamental analysis. What is beneficial in using the models is that it forces you, as future resort owners, to begin thinking about different scenarios in relation to how the market is pricing capital.

These models should be considered to assist with your risk-based capital calculations, in conjunction with your other capital analysis and assumptions. It is imperative that the structure required for capitalization offers the highest return while minimizing your weighted cost of capital.

Various Debt and Equity Instruments

There are several debt and equity instruments. These instruments are used to create financing decisions for the firms. The debt instruments are obligations that enable the issuing party to raise funds. Promising to repay a lender in accordance with terms of a contract does this. (Internet Search: Investopedia). Types of debt instruments include notes, bonds, certificates mortgages, leases and other agreements between a lenders and borrowers. The debt instruments allow participants to transfer the ownership of debt obligations from one party to another. Firms issue bonds to finance operations. Debt agreements are quite strict and are often tailored to the need of borrower's business risks.

Various restrictions may include conditions on interest rates or covenants relating to working capital, financial leverage, and capital purchases. A basic principle of financing is that debt is considered riskier than equity, as debt-financing costs have to be met regardless of the company's financial position. (Bharath, K. 2005, p. 62). Costs of debt vary based on types of debts and the credit rating of the company seeking the debt. Costs associated with debt include application fees, standby fees, monitoring fees, and related administration charges. The interest rate is a function of risk and the payment on debt is regarded as a pretax expense. Forms of debt instruments include fixed rate, floating rate, funded or unfunded debt, callable and sinking- fund debt, senior and subordinate debt, secured and unsecured debts, investment grade and junk debt, domestic and international debt, publicly traded debt and private placement instruments.

Equity financing relates to share capital required to support operational activities by selling common or preferred stock to individuals or institutional investors. In return for the money paid, the shareholders receive ownership interest in the corporation. Preferred shares have higher claim on assets and earnings of the company. Each company has its own provisions for preferred shares but will generally offer fixed dividends and potential appreciation. In the event of a financial problem, the debt-holders have first priority followed by preferred shareholders, then common stock

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