The Bono Company Ltd, which is effectively controlled by the Bono family although they now own only a minority of shares, is to undertake a substantial new project which requires external finance of about Rs 240 million, a 40 % increase in gross assets. The project is to prepare and market a new product and is fairly risky. About 70 % of the funds required will be spent on land and buildings. The resale value of the land and buildings is expected to remain about, or above, the initial purchase price. Expenditure during the development period of 4 - 7 years will be financed from Bono's other revenues with a consequent strain on the firm's overall liquidity.
If, after the development stage, the project proves unsuccessful then the project will be terminated and its assets sold. If, as is likely, the development is successful, the project's assets will be utilised in production and Bono's profits will rise considerably. Thus, if the project proves to be extremely successful then additional finance may be required to further expand production facilities.
At present Bono is all equity financed.
The Financial Manager is uncertain whether he should seek funds from a financial institution in the form of an equity interest, a loan (long or short term) or convertible debentures.
Required:
(a) Describe the major factors to be considered by Bono in deciding on the method of financing the proposed expansion project.
(b) Briefly discuss the suitability of equity, loans and convertible debentures for the purposes of financing the project from the viewpoint of:
(i) Bono; and
(ii) The provider of finance
(c) Clearly state and justify the type of finance recommended for Bono.