以下文字节选自历年真题，划线部分为结合案例进行分析的部分，未划线部分为通用文字（需要熟练掌握），考试时结合案例进行具体分析。

Cost of borrowing

Whilst debt is usually cheaper than equity finance, it will place additional obligations to pay out more cash in the form of interest regardless of profitability. Failure to pay this can result in action being taken to wind up the company. The current interest cover is 23 times indicating that the interest payment will not be particularly vulnerable to a drop in profits.

If the hotel is the chosen option, you need to give consideration to Nehby’s ability to generate cash to cover additional interest payments on $21m which based on the current ratio of interest to loans and overdraft of approximately 4·4% (53,016/(1,065,010 + 139,908)) is $924,000. Under this option, the debt burden would increase substantially. In the first year of the hotel operation the new hotel is not generating any net cash inflows and if we assume the same financial performance as in the current year, the interest cover will drop from 23 times to 1·2 times which will substantially increase the default risk.

Gearing is the ratio of debt to equity. Using the formula non-current liabilities/ordinary shareholders funds + non-current liabilities, gearing is $1,065,010/$1,233,758 + $1,065,010 = 46·3%. Without raising any new finance, at 31 March 20X0 gearing has marginally exceeded 45%, the acceptable level for the bank, so taking on more debt is not looking feasible and on the contrary Nehby will urgently need to re-balance its gearing to comply with the terms of the covenant.

Security

Many lenders will require assets to be pledged as security against loans. The statement of financial position shows the value of non-current assets as $1,623,650. There is insufficient existing asset security, another indication that further borrowing may not be an option. You would also need to consider whether there are any further covenants written into the existing debt arrangements which would prevent any increase in debt finance.

The existing bank covenant may be renegotiated on better terms if further bank borrowing is taken out and secured on the non-current assets, including the new hotel.

Risk

Investment in the hotel would be a product diversification strategy but is within the hospitality industry so is not substantially spreading the business risk. The hotel is not an area of the hospitality sector you have operated in before, creating uncertainty about whether the skills and competences which have contributed to the growth of the business to date can be transferred into the new venture. The hotel sector is also characterised by high operational gearing. Labour is a significant fixed cost in the hospitality industry which is largely independent of demand and fluctuations in demand could lead to a greater variability in operating earnings. This combination of financial risk and operational risk may be too high for Nehby to accept on its own.

Equity finance and control

You have stated that you do not have the appetite or capacity to finance this alone. As a private limited company, the shares may not be offered to the general public so there is no ability to raise new equity finance through share markets. You may want to inject more capital yourselves and so retain control of the business but you have noted the investment is too big to do all on your own. Therefore there is a need to turn to a venture capitalist to obtain the equity finance required. This will alter your voting control in the business and you will be unable to make decisions without reference to the venture capitalist who will be investing in order to participate in your success. Venture capitalists are often looking to an eventual flotation of the company after the term of their agreed investment has expired. Additionally they typically look for an annual rate of return of 20% or more on their investment which has yet to be factored into the computations.