unit-6-sources-of-long-term-finance-and-underwriting

Unit-6 Sources Of Long-Term Finance And Underwriting

In this unit we shall examine in detail the nature and importance of long-term finance.

Write explanatory notes on the following; a) Retained profits as a source of long-term finance. b) Foreign sources of long-term finance. c) Restrictions on investment in shares by non-resident Indians?

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Learning Pundits Content Team

Written on Apr 15, 2019 6:28:11 PM

a) Retained profits as a source of long-term finance

An important source of long-term finance for ongoing profitable companies is the amount of profit which is accumulated as general reserve from year to year. To the extent profits are not distributed as dividend to the shareholders, the retained amount can be reinvested for expansion or diversification of business activities. It can also be used for renovation of assets or modernization of plant and equipment. It ay be interpreted that the existing shareholders provide the finance. Hence, the company must decide to reinvest profits only when the rate of return is comparable with that of other similar companies. Moreover, a part of the profits must be distributed as dividend keeping in mind shareholders' expectation and the effect of dividend rate on the market price of shares. Retained profit is an internal source of finance. Hence it does not involve any cost of floatation which has to be incurred to raise finance from external sources. Further, the company does not have to face the uncertainties of external financing. The only drawback of this source of long-term finance is that it depends on the availability of adequate profits for retention.

b) Foreign sources of long-term finance

Funds can also be collected from foreign sources which usually consist of:i) foreign collaborator, ii) international financial institutions, and iii) non-resident Indians (NRIs)

Foreign Collaborators: If approved by the Government of India, large companies may be able to secure long term finance on the basis of collaboration agreements with companies abroad. Foreign collaboration may, thus, enable Indian companies to secure equity capital from abroad through the subscription of foreign collaborator to their share capital, or by way of supply of technical knowledge, patents, drawings and designs of plants or supply of machinery.

International Financial Institutions: There are a number of international financial institutions which provide long-term funds for industrial development all over the world. The most important among them are: i) The World Bank, and  ii) International Finance Corporation.

The World Bank grants loans for specific industrial projects of high priority included in the national development plan. The loans have to be guaranteed by the Government of India, and may be given directly to an industrial concern, or through a Government agency, or may be given to the IOBI for refinancing to companies.

The International Finance Corporation (IFC) was established in 1956. It is an affiliate of the World Bank. As you know the World Bank grants loans only to governments of member-countries or private enterprises with guarantee of the concerned government and it does not provide risk capital to enterprises in .member-countries. IFC was set up to assist the private undertakings without the guarantee of the member-countries. It also provides them risk capital. IFC grants loans to industrial firms for a period of 8 to 10 years. Such loans do not require Government guarantee. Industrial concerns with investment plans drawn in accordance with the priority laid down under the national development plans can secure long-term loans from the IFC. But the corporation considers loan applications involving large amounts of about $100,000 or more from organizations having total assets of the value of at least $500,000.

Non-resident Indians: Persons of Indian origin and nationality living abroad (Non-resident Indians) are also permitted to subscribe to the shares and debentures issued by companies in India. A non-resident or a company controlled by a non-resident can invest up to a maximum of 5% of the paid up equity capital of an Indian company. New issues of shares or debentures by an industrial company can be subscribed by non-resident Indians to the extent of 40% of the new issue subject to a quantity ceiling of Rs. 40 lakh if the non-resident wants to have the option of repatriating the investment i.e. sell the shares and debentures and get the amount remitted abroad. However, exceptions are allowed in the case of priority industries like industrial machinery, scientific instruments, Fertilizers, chemicals, drugs, export industry, hotels, etc.

c) Restrictions on investment in shares by non-resident Indians

New issues of shares or debentures by an industrial company can be subscribed by non-resident Indians to the extent of 40% of the new issue subject to a quantity ceiling of Rs. 40 lakh if the non-resident wants to have the option of repatriating the investment i.e. sell the shares and debentures and get the amount remitted abroad. However, exceptions are allowed in the case of priority industries like industrial machinery, scientific instruments, Fertilizers, chemicals, drugs, export industry, hotels, etc.

Non-resident Indians can also subscribe to the shares and debentures issued by companies in India subject to certain restrictions. To the extent profits are not distributed as dividends, the retained amount becomes a source of long-term finance for companies



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