Agriculture Reference
In-Depth Information
with the planned use for the funds, as well as with the long-term prospects for the existence
of the fi rm and its solvency. The purpose of the long-term loan is most often for real estate,
that is, for land and buildings. As the lender examines requests for long-term loans, he or she
becomes deeply concerned with evaluating the past track record of the fi rm, the skill and
ability of the management team, and the stability of the business enterprise. The collateral
for long-term loans is usually a mortgage or claim on the fi xed assets of the fi rm, and
the longer the period of the loan, the riskier it becomes for the lender. There is always the
chance that an unstable enterprise will be forced to dispose of fi xed assets in a forced sale,
where these assets may bring only a fraction of their value at the time the loan was closed.
Long-term loans are nearly always amortized over the loan period and secured by a
mortgage or claim on a specifi c fi xed asset. Sometimes bonds are used to secure long-term
capital, but a small fi rm seldom has the size or fi nancial strength to sell a bond issue. Because
Doug Davies plans to build new storage facilities at his new site as well as enlarge the offi ce
building to accommodate the consolidated business, he will also need a long-term loan.
Equity capital
If the agribusiness is not in a strong fi nancial position (solvency is discussed in
Chapter 10
)
or cannot meet the stiff collateral requirements set by lenders, it may have to turn to equity
capital to meet its long-term needs.
Equity capital
can be used for the same purpose as
borrowed funds, but there is an important difference: equity capital does not have to be
repaid. It becomes a permanent part of the capital of the business. Equity capital is secured
either by reinvesting profi ts from the business or by fi nding investors who are willing to
invest additional funding in the business.
Lenders pay particular attention to equity when they are making long-term loan commit-
ments, and they may insist that a larger percentage of the owner's money be invested in the
capital of the agribusiness than the lenders'. This is particularly true of new businesses,
where risks are more diffi cult to calculate. Some owners do not wish to increase their equity
for various reasons, but it may be the only prudent way of securing long-term capital funds.
Doug Davies will strongly consider expanding his equity base. Inasmuch as his business is
already organized as a corporation, it will be easier for him to make the move should he so
desire. (A more detailed analysis will appear later in the chapter.)
The cost of capital
When a business borrows money, it incurs special costs that are paid to the lender. One of
these is
interest
, but interest is not the only cost of borrowing money. Several other factors
affect the net cost of borrowed capital:
1.
Repayment terms and conditions
2.
Compensatory balances, points, and stock investments
3.
The income tax bracket of the fi rm
Repayment terms
The repayment terms and conditions directly affect the rate of interest that is actually paid.
If Doug Davies borrowed $100,000 for one year at the stated interest rate of 8 percent, the
amount of interest paid would be $8,000. At the end of the year Doug would pay the lender
