ANSWER TO QUESTION # 1
SHORT TERM APPROACH
The short term approach in this case would be that the firm should go for vanilla loan, as there is no risk of loss in providing vanilla loan to the firm. Because the firm would be earning the interest income on the loan provided to the firm.
Providing vanilla loan to the firm would benefit the firm for the short term as the loan would be redeemed after a specific period of time, therefore, there would be no interest income after the certain period of time.
The firm should look at the feasibility of the project as well as the firm should also check and evaluate the credit worthiness of the client as well as the firm should also determine the feasibility of the project to which the firm is providing loan. The firm should check whether there is the potential in the project that the loan would be redeemed easily in a suitable period of time.
LONG TERM APPROACH
The firm should go for equity financing as it would benefit the firm for a long term till the shares are held in the client. The firm should first analyse comprehensively the business model of the client as well as the firm should also review the previous records of the clients to indicate the sustainability and viability of similar projects.
However, the firm could also do partial financing through vanilla loan as well as partial financing through equity as it would hedge the risk of loss to some extent.
ANSWER TO QUESTION # 2
Risks of the short term approach
- There is a risk that the client may plunge into liquidation due to which the firm would not be able to recover the amount of loan from the client. This would decrease the overall profitability of the firm as well as it would also lead to cash flow problems to the firm.
- If the inflation rate is increased during the period of the contract then this would result in decrease in overall income of the firm and subsequently the profitability of the firm as the time value of money would decrease over the term period.
Potential rewards of the short term approach
- The firm would earn interest income even if the project would not be able to generate estimated cash flows.
Risks of Long term approach
- Financing through equity also has a risk of loss as if the project would not be able to generate probable cash flows, then it would negatively effect on the investment made by the firm
- This would decrease the motivational level of the IO’s as well as it would further increase the frustration level of IO’s as they were looking forward to finance the project through vanilla loan.
Potential rewards of Long Term Approach
- The firm would be earning a diversified amount of dividends for a long time.
- Partial financing through equity and vanilla loan, would be beneficial in the sense that if the project proved to be a total loss then at least the interest income would cover up the loan to some extent.
ANSWER TO QUESTION # 3
Following are the factors that are considered while making decision.
- The benefits associated with the different approaches as well as the risks associated with the projects are considered. All the risks and benefits associated with the different approaches are evaluated comprehensively in order to make a fruitful decision.
- The feasibility and suitability of the approaches with the project is considered.
- Any probable harm to the interest of the employees with respect to such decision is considered .i.e. the probable effects on the motivational level of the effected parties, which might be directly or indirectly effected by the decision.
- The opportunity cost of financing through equity or financing through vanilla loan is also considered in order to make operational and optimal decision.
Director Infra Structure And Energy Segments Case Solution
EXTRA QUESTIONS
ANSWER TO QUESTION # 1
I was working as an assistant manager in a medium-sized company last year. The company does not have a proper organisational structure, for e.g. the human resource manager of the company is supposed to act as an owner in the absence of owner as well as she also acts as a supervisor in the absence of supervisor. Moreover, there was a poor and a hostile working environment as well as the employees are burdened with the tasks they are even unable to handle.................
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