• You have been contracted to provide corporate advice for Whatsgoingon Ltd., a tech start-up company that keeps users abreast on the latest nightlife in several major cities around the world. Currently, it has little in the way of debt and has financed its operations so far from venture capitalists that hold a 30% stake in the firm. The remaining equity holders comprise of the owner-managers, aka top management team (40%), and small retail investors (30%). It pays a corporate tax rate of 30%. Its current market valuation is at $10 million and it needs to raise $5 million for a substantive growth project expanding its operations to a number of mid-tier cities in the countries it already operates in. Based on market estimations, the beta of the stock is 1.7. The current market premium is 3% and government short-term bonds currently have a yield of 2%.

The CEO of Whatsgoingon Ltd. is considering raising the additional $5 million by issuing bonds rather than seeking more equity, as this would further dilute their control of the company. From initial discussions with the investment house that would issue the bonds, the going coupon payments it would have to offer in order to make the bonds attractive to the market would attract 8% interest per annum with a five year duration (the expected timeframe of the project).

Unlike the CEO, the CFO is cautious about debt financing as she notes that many other successful competitor firms do not debt finance and the coupon payments due on the bonds seem quite steep. What advice can you provide to the top management team in considering to debt or equity finance their expansion.

Based on the reply you provided, the CFO then also tells you there is a cheaper option in securing short-term financing, with a duration of 12 months, that only attracts a 6% interest. Therefore, another option may be to borrow on the short-term market and rollover the debt every year for five years. What advice would you give in consideration of this option?

The CEO suggests it might be possible to reduce the cost of equity financing by decreasing the company’s Beta. Is this a plausible solution to reduce the cost of equity and is it also practical to implement? In answering this question be sure to explain clearly to them what a Beta is and how it functions.

Finally, the CEO again raises the issue surrounding control of the firm and suggests that if they can sell stock to small retail investors then the top management team can still retain control of the firm which will benefit everyone. From a corporate governance perspective is the CEO correct and what advice would you give on this matter?