Essay: To raise funds externally or use the owner’s funds?

Should Rendezvous Holdings raise funds externally or use the owner’s funds for the establishment of their new restaurant located in the upcoming Sunshine Coast hospital?
1.2 PROPOSED METHODOLOGY:
1.21 RATIONALE FOR STUDY
Rendezvous Holdings plans to open a new restaurant in the university hospital that will be opening in the Sunshine Coast by the start of 2017. The restaurant will cost approximately $200 000 +- to set up initially. Rendezvous Holdings needs to acquire funds to make this plan a reality. The company currently raises funds externally to fund new projects, however is reconsidering its strategy to ensure it is the most beneficial funding source going forward, as this is the first of several new restaurant openings and funding decisions now could affect future ability to borrow. The aim for Rendezvous Holdings is to set up a financially stable chain of restaurant.
1.22 AREAS OF SYLLABUS TO BE COVERED
Unit 3: Finance and Accounts
• 3.1 Sources of Finance
• 3.7 Investment Appraisal
– Net Present Value Formula
1.23 POSSIBLE SOURCES OF INFORMATION
• Rendezvouz Holdings website
• Rendezvouz Holdings owner (Mr P. Sridhar)
• Acquire Capital which is an existing lender to Rendezvous Holdings (Mr N. Pasricha)
• Bureau of Statistics for Sunshine Coast
• National Australia Bank (NAB) website to ascertain interest rates (NAB is Rendezvous Holdings banker.
1.24 ORGANIZATIONS & INDIVIDUALS TO BE APPROACHED
• Rendezvouz Holdings (Business being investigated)
• Mr P. Sridhar (Owner of Rendezvouz Holdings)
• Mr N. Pasricha (advisor to Acquire Capital and former director of the finance company who are current lenders to Rendezvouz Holdings)
1.25 METHODOLOGY
Research will mainly be carried out mostly at primary level but some research will also be done at a secondary level. The primary research will be conducted through interviews with the owner of Rendezvous Holdings and by examining his profit forecasts and other financial data. The interview will be conducted in order to learn the company’s strategic, and financial plan and current funding arrangements. The interview also should contribute to the understanding and appreciation of the industry, as well as its venture risks and the structure of the company itself.
Secondary research will also be carried out in order to collect data and information related to the industry, the financial aspects of the company and the environment (external) within which the company will be operating in (Sunshine Coast).
Many different forms of data will be collected for the investigation. This should include the company’s specific financial strategy plans, its business prospectus submitted to the hospital, profit and loss statements from a similar already existing restaurant owned by the company, predicted capital and revenue expenditure for the proposed restaurant and business plans directly from the business.
1.26 ANTICIPATED DIFFICULTIES
Possible Difficulties
Solutions
Biased interview questions due to vested interest
Verification of data through utilising secondary resources
Uncertainty of interest rates
Complementary information from independent sources
Uncertainty of future revenues and expenditures
Will look at forecasts to be able to adjust calculations accordingly
Look at financial forecasts of Rendezvouz Holdings to determine future expenditures
TASK
COMPLETED BY
COMPLETED (MARK WITH X)
Read Assignment
01/07/15
X
Interview
05/07/15
X
Complete research proposal
20/07/15
X
Collect and analyse data
30/07/15
X
Research findings and analysis
10/08/15
X
Analysis and conclusions
24/08/15
X
Draft of assignment complete
14/09/15
X
Assignment finished
12/10/15
X
1.27 ACTION PLAN
CONTENTS PAGE
TITLE
PAGE
1.0 Research Proposal
3
1.1 Research Question
3
1.21 Rationale for study
3
1.22 Area of Syllabus to Be Covered
3
1.23 Possible Sources of Information
3
1.24 Organizations and Individuals to be Approached
3
1.25 Methodology
3
1.26 Anticipated Difficulties
4
1.27Action Plan
4
2.0 Executive Summary
6
3.0 Introduction
7
4.0 Research Question
9
5.0 Methodology Employed
10
6.0 Results and Findings
12
7.0 Analysis and Discussion
13
8.0 Conclusion and Recommendations
16
9.0 Bibliography
17
10.0 Appendix
18
2.0 EXECUTIVE SUMMARY
The investigation explored the options available to Rendezvouz Holdings to source the finance needed for their new restaurant venture in the upcoming hospital in the Sunshine Coast. Therefore the research question that I chose was ‘Should Rendezvous Holdings raise funds externally or use the owner’s funds for the establishment of their new restaurant located in the upcoming Sunshine Coast hospital?’.
To come to a conclusion on whether or not Rendezvouz Holdings should raise funds externally to fund their new restaurant, I evaluated all of the options that were available to the owner, in terms of funding, using the Net Present Value (NPV) method as the main indicator. The sources that I evaluated to come to a conclusion on the research question was:
• Bank funding by way of a medium term loan
• Finance company funding through a company that has provided finance in the past (Acquire Capital)
• Internally generated funds from the owner of Rendezvouz Holding’s own resources
New equity from third parties was not considered because the owner specifically said he did not want this, because of a past bad experience.
The conclusion that I came to at the end of the investigation is that Rendezvouz Holdings should raise funds externally to fund their new restaurant located in the Sunshine Coast hospital that is being built. In particular I would recommend gaining funds from bank loans rather than the finance company that Rendezvouz Holdings has borrowed from in the past. I would also recommend using the bank loans for longer than the 2-year period, which the owner is anticipating, as the owner’s opportunity cost, is much higher than the bank interest rate.
(1+r)t
3.0 INTRODUCTION
Rendezvouz Holdings has been in the restaurant and food business for more than 10 years in Queensland. (Sridhar, 2015)Rendezvouz Holdings owns 10 restaurants and 5 other businesses, making a total of 15 businesses run by Rendezvouz Holdings. The business employs local staff and sources its supplies locally thus stimulating local demand and supports the local economy. Rendezvouz Holdings already has a restaurant located in the Gold Coast University Hospital. This is the model on which the new expansion is being based. The restaurants that are part of the Rendezvouz Holdings group are both externally and internally funded depending on each different restaurant.
Rendezvouz Holdings is planning to open another restaurant in Queensland at the upcoming hospital in the Sunshine Coast. The estimated cost of opening this restaurant is over $200,000. (Interview with Sridhar, 2015) At the moment the owner of Rendezvouz Holdings, Sridhar, is contemplating whether or not to use external sources to finance his new restaurant. The sources that he is looking into are banks, the finance company that funded the Gold Coast Hospital and a further capital injection from himself. This therefore has led me to my research question, which is: ‘Should Rendezvous Holdings raise funds externally or use the owner’s funds for the establishment of their new restaurant located in the upcoming Sunshine Coast hospital?’.
In deciding the sources of finance for the expansion, the owner, Sridhar, has certain requirements (Interview with Sridhar, 2015):
• The funding must be at a cost which will allow operational profits to be generated from the first year
• The funding should not reduce the company’s ability to raise funds in the future, because this restaurant investment is only part of a longer-term growth plan.
• The owner has had previous difficult experiences where investors have been over-involved with operations and dictating operational decisions. Sridhar wishes to maintain maximum control and minimal reporting to the provider of funds.
• Sridhar wants to repay any borrowings within 2 years
The sources of funds that are immediately available to Sridhar are as follows:
• Bank funding by way of a medium term loan or an overdraft facility
• Finance company funding through Acquire Capital, a finance company that has provided finance in the past
• Internally generated funds from his own resources
4.0 RESEARCH QUESTION
Should Rendezvous Holdings raise funds externally or use the owner’s funds for the establishment of their new restaurant located in the upcoming Sunshine Coast hospital?
5.0 METHODOLOGY EMPLOYED
The sources that I used in the end for this report were predominantly primary sources however; secondary sources were used to complement my findings.
The primary sources that I used were:
• Interview with Rendezvouz Holdings Owner (Mr P.Sridhar)
• Financial statements of a business similar to the proposed business
• Financial strategy plans
• The business prospectus submitted to the Sunshine Coast University Hospital
• Profit and loss statements from a similar already existing restaurant owned by the company
• Predicted capital and revenue expenditure for the proposed restaurant provided by Rendezvouz Holdings
• Business plans directly from the business.
The secondary source that I used were:
• Interest rates from a number of banks
• Information from Acquire Capital about rates and security
• Australian interest rates forecasts
To evaluate these sources I will be using the Net Present Value formula (NPV). The NPV is a formula that is defined as “the difference in summation of the present values of future cash inflows” (Muchena, Pierce and Lominé, 2014), the present value being today’s value of an amount of money available or to be spent in the future. The actual formula can be seen as Figure 1 in the Appendix. This basically means that it is the difference between the present value of cash inflows and the present value of cash outflows. The NPV formula is used for capital budgeting when analysing the profitability of an investment or project. The NPV is related to this particular investigation, as we are able to decide which funding option would be the most profitable for Rendezvouz Holdings, by analysing future cash flows in terms of todays money equivalent.
As the owner has considerable experience in the industry, with 10 restaurants and 1 of them in a similar hospital in Gold Coast (Queensland), I will take his estimates of set up costs and future revenues and costs as well founded. However, in order to further ensure that the owner’s estimates are well founded, during my interview with the finance company I will ask for further validation based on the Finance company’s experience with similar companies and their past experience with Rendezvous.
However, NPV will not be used in isolation and the owner’s specific requirements in terms of retaining control and payback period will also be considered.
6.0 RESULTS AND FINDINGS
The findings that I obtained were to help me to consider whether or not Rendezvouz Holdings should use external sources to fund the upcoming restaurant in the developing Sunshine Coast hospital. This is because they help provide a clearer view on the exact amount of money that will be needed to open and run the restaurant. This can be particularly seen in table 1 – which is located in the appendix.
As well as this, table 2 shows the application of the NPV formula to all of the available sources of funding that Rendezvouz Holdings can use. This will help me come to a conclusion on which source of funding Rendezvouz Holdings should use as the NPV formula tells us which option would be most profitable for the company. The interest figures that I used for the NPV calculations were drawn from table 3, however I rounded the interest rate to be 5% as table 4, which is a forecast for interest rates in Australia provided by NAB (the bank the business uses), predict that interest rates shall be rising and since the NPV’s are for after 2 years of opening the restaurant, which would make it 2019, I felt it would be more accurate to use a higher interest rate than the rate which is relevant currently-2015.
I found that the bank and finance company have very different applicable rates of interest (5% and 18% p.a. respectively) and other terms and conditions. The finance company’s security requirements are also greater than that of the bank in this case. However, the finance company’s documentation needs are far less, they have a much faster loan application process compared to banks, their representative stated their willingness to lend would be high because of past experience with Rendezvous and the Finance company’s ongoing reporting requirements are low compared to banks.
Whilst funds provided by the owner may appear to have no cost, the fact that these funds are currently invested, means that the owner’s funds have an effective opportunity cost of 9% p.a.
I also found that future cash flows are estimated at $200,000 set-up costs and $150,000 gross profit p.a. before interest and tax. If interest rates are factored in, then the positive NPV of the 3 options considered is $78,912 using bank funds, $75,552 using finance company funds and $77,940 using the owner’s funds.
7.0 ANALYSIS AND DISCUSSION
There are 2 crucial aspects in considering whether Rendezvouz Holdings should use external funds in setting up their new restaurant.
Firstly whether the bank or finance company will actually advance funds. From our discussion with the finance company Acquire Finance it appears that they would be willing to advance $200,000. The owner’s expectation is that NAB would also be willing to advance funds. Both parties believe the Rendezvouz management is credible and experienced and their profit forecasts are realistic.
Secondly is the issue of interest rates.
EXTERNAL FUNDS- BANK LOAN
I obtained the bank interest rate for small business loans from the National Australia Bank from their website. The NAB is one of Sridhar’s bankers. This is a fixed term, fixed rate facility, with a full repayment at the end of the 2 year term. It has to be secured by personal guarantee and on the assets of the rest of the business. The NPV after two years for this source is 278912.
Advantages
Disadvantages
NPV is quite high, meaning that the future cash flow for the company will be quite high.
The loan is required to be secured by a personal guarantee. This can put a strain on that relationship if repayments are not followed, as well as the fact that that guarantor will have to pay the repayments.
The bank is unlikely to close down, therefore reducing the risk of unresolved business and not receiving the funds.
Since the money is borrowed against business assets, the owner is forced to put his entire business (his entire earnings) on the line
The money is borrowed against business assets and does not affect personal assets, therefore not risking personal life.
The bank will most likely pressure the company into voluntary administration, if company is unable to repay bank.
The repayment schedule’s long- term debt maturity, associated with this option, allows for the owner to ride the highs and lows of the business, without the worry of not being able to repay the bank in a shorter time period. This is especially important, because the expenditure at high class dining restaurants is highly correlated to discretionary income availability.
If administration occurs, when it comes to voting they are likely to vote for liquidation rather than DOCA (Deed of Company Arrangement), which would cease the business from continuing operations.
EXTERNAL FUNDS- FINANCE COMPANY
The finance company is one that Sridhar has used before. The loan is fixed term and fixed rate, unless there is a default on interest, in which case the annual rate goes up by 12 % pa. (Sridhar,2015) (N.Pasricha, 2015)The loan is secured on the personal residence of the borrower. The NPV after two years for this source is 275553. Therefore, this may be a good option for the business to obtain funds as the NPV is quite high and as well as the fact that it has a fixed rate.
Advantages
Disadvantages
NPV is quite high, meaning that the future cash flow for the company will be quite high.
The loan involves the owner to borrow against personal property therefore putting his personal life and his family’s lifestyle at risk.
Rate rises do not matter as the loan is on a fixed rate basis, therefore if the variable rate does rise, Sridhar will be benefitting and paying less than the variable rate that may be high.
If the owner does not manage to pay interest on time, the rate that his payments goes is extremely high and Sridhar will most likely not be able to pay that money.
It is possible for the loan to have break fees if Sridhar chooses to change or pay off his loan within his set period of the loan. This is especially likely as the loan is borrowed against his personal property, so if he chooses to sell his house he will have to pay a break fee.
Rates fluctuate al the time, therefore if rates fall Sridhar will be paying more than the variable rate and will not be able to benefit from the rate drop.
INTERNAL FUNDS- OWNERS FUNDS
For the 3rd option, the owner using his own funds, we have used the rate of return he is receiving from other investments as the cost of funds – this being his opportunity cost of using funds in this business. The NPV after two years for this source is 277940.
Advantages
Disadvantages
More flexibility on how much to contribute to the new venture accordingly to what your business can handle investing.
This method comes with a less structured repayment system, therefore risking the owner never repaying and/or remaking the money that he invested into the new venture
The business will be able to avoid obligations that come with taking out a loan or getting funds externally. E.g. repayments with interest.
He forgoes the opportunity to improve his reputation as a reliable debtor to the financial situations. This would have come in handy when trying to borrow even higher amounts in the future.
The NPV is high and therefore the expected cash flow for the company will be high.
It will be harder for the business to obtain a bank over draft in the future
The business will be able to avoid paying the costs associated with taking out a loan.
The business will have less capital to respond to other crisis’ that may happen e.g. Financial Crisis, Competition overtaking customer basis
In carrying out our NPV calculations, we have had to assume that cash flows happen at the end of each year, except for the loan, which is immediate draw down and payable after 2 years. We have calculated NPV on a 2-year term as this is according to the business owner’s request.
8.0 CONCLUSION & RECOMMENDATIONS
To conclude based upon the most beneficial NPV, I would recommend using external sources to fund Rendezvous Holdings upcoming restaurant in the future hospital in the Sunshine Coast. This is because on NPV terms, it appears that the bank loan is the most beneficial source of funds with a NPV value of $78,912 at the end of 2 years; followed by using his own funds which would have a NPV of $77,940 at the end of 2 years and the least beneficial is using the finance company which would have a NPV of $75,553 at the end of 2 years. Therefore, out of the two external sources of finance I would recommend using the bank loan, even though there are some non-NPV advantages to using the finance company or using own funds.
In comparing other conditions of the bank loan and using his own funds, the bank condition of a personal guarantee and the security of the rest of the business may reduce the ability of the owner to borrow further funds in this 2 year term from other sources.
As well as this the external funds allow the business to have the opportunity to borrow a higher amount of money in the future as banks and/or finance company take into account previous loan history when considering loan applications.
It is worth noting that it may be worth considering using the bank funds for longer than the 2 year period that the owner nominated as his opportunity cost is much higher than the bank interest rate.