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| *Ostroff, Fair and Company>>>Financial Services |
How does a firm decide to borrow rather than diluting shares? |
How do firms make decisions on financing? What are some quick and dirty ways to decide whether a company should borrow rather than diluting shares? They utilize financial modeling methods. You can pick up some textbooks on the subject and read about it yourself as the exact methods are complex topics. But basically, they simulate 'what if' scenarios by seeing how much external financing is really needed; adjust policies if needed. Borrowing costs are relatively easy to figure out, and equity dilution is usually determined through a Miller-Modigliani method of dilution. The end objective is to maximize shareholder value usually through a present value valuation method. There's really no 'quick and dirty' method. You either do it right or do it wrong. any other way is no different than taking a crystal ball and moving your hands over it to try to come up with an answer. That's why they pay the high bucks to people like me! Source(s): MBA, MSF Private Equity Partner. They decide on financing by return on capital. If it is favorable the company can grow(increase the bottom line or net worth) by borrowing. Diluting shares doesn't increase the net worth all by itself and is usually an investment in human capital. There are many issues to take into consideration. - some privately owned companies don't wish to have other persons own stock, or the owners don't want to dilute to keep a controlling stake in the company - the shares might be difficult to sell (in particular if the firm is not publicly listed) - the seller might prefer cash - the acquirer might not be able or not willing to take another loan (for various reasons). - borrowing or diluting has an effect on the return on equity. If the return on equity is higher without diluting then diluting seems preferable. In general quick ways to check this out is the debt/equity ratio and compare it with the industry average. |
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