Question 1 (25 Marks)

1. Sources of finance are the most explored area especially for the entrepreneurs about to start a new business. It is perhaps the toughest part of all the efforts.

There are various sources of finance classified based on time period, ownership and control, and source of generation of finance. On the basis of a time period, sources are classified into long term, medium term, and short term. Ownership and control classify sources of finance into owned capital and borrowed capital. Internal sources and external sources are the two sources of generation of capital. All the sources of capital have different characteristics to suit different types of requirements.

Required: Explain the following three classifications of financing with the aid of examples.

• Short term (5 Marks )
• Medium term (5 Marks)
• Long term (5 Marks)

2. Debt is a wonderful way of increasing ones wealth, because the cost of debt is lower than the return offered by the business. One could conclude that gearing (taking on debt) could increase rate of return without increasing the level of business risk. However, there is a down-side that could (and often does) lead to business failure. If a person invests his own money, or even money from other shareholders, he expects to receive interest or its equivalent in the form of a dividend, as well as an increase in the value of the shareholder contribution over a period of time. If, however, he borrows money, he has to pay interest every year, regardless of how well or poorly the business is performing. On top of that, he may also have to make an annual capital repayment. If he cannot, the bank will foreclose on the loan and repossess the assets that have been given as security for the loan in the event that that debt cannot be repaid.

Required: Explain 5 advantages and 5 disadvantages of debt gearing. (10 Marks)