Table Of ContentHandbook of
Singapore - Malaysian
Corporate
Finance
Edited by
Tan Chwee Huat, BAcc (Hons), MBA, MSc, PhD,
Dean, Faculty of Business Administration and Head,
Department of Finance and Banking, National University of Singapore
Kwan Kuen-Chor, BSocSc, MBA, PhD
Senior Lecturer, Department of Finance and Banking,
Faculty of Business Administration, National University of Singapore
Butterworths
Singapore - Malaysia - Hong Kong
1988
THE BUTTERWORTH GROUP OF COMPANIES
SINGAPORE BUTTERWORTH & CO (ASIA) PTE LTD
30 Robinson Road #12-01 Tuan Sing Towers,
Singapore 0104
MALAYSIA MALAYAN LAW JOURNAL SDN BHD
10th Floor Wisma Hamzah Kwong Hing,
No 1 Leboh Ampang,
50100 Kuala Lumpur
AUSTRALIA BUTTERWORTHS PTY LTD
Sydney, Melbourne, Brisbane, Adelaide, Perth, Canberra and
Hobart
CANADA BUTTER WORTHS CANADA LTD
Toronto and Vancouver
IRELAND BUTTERWORTH (IRELAND) LTD
Dublin
NEW ZEALAND BUTTERWORTHS OF NEW ZEALAND LTD
Wellington and Auckland
UK BUTTERWORTH & CO (PUBLISHERS) LTD
London, Edinburgh
UNITED STATES BUTTERWORTH LEGAL PUBLISHERS
OF AMERICA St Paul, Minnesota
Seattle, Washington
Boston, Massachusetts
Austin, Texas
D & S PUBLISHERS COMPANY
Clearwater, Florida
©
Butterworth & Co (Asia) Pte Ltd
1988
All rights reserved. No part of this publication may be repro-
duced or transmitted in any form by any means, including
photocopying and recording, without the written permission of
the copyright holder, application for which should be addressed
to the publisher. Such written permission must also be obtained
before any part of this publication is stored in a retrieval system
of any nature.
ISBN 0-409-99548-7
Typeset in Singapore by Times Graphics and
printed in Malaysia by Peter Chong Printers Sdn Bhd.
Preface
In recent years, financial markets all over the world have become
increasingly sophisticated and complicated. As an emerging financial
centre in Asia, Singapore is witnessing the introduction of many new
financial instruments, offering a wider range of opportunities for
investors in terms of maturity periods, liquidity and the level of risk. At
the same time, the financial markets and institutions in Singapore are
influenced by events in other financial centres in the world.
In view of the increasing complexity in the financial system, it has
become more important for financial managers, bankers, professional
investors, businessmen, students of finance and the general public to be
aware of the major events in the financial world. In order to do that, they
must have some basic knowledge in corporate finance.
The purpose of this handbook is to provide a comprehensive reference
for the practitioner as well as the general public. This is not an easy objec-
tive. Some specialized topics will be dealt with in great depth and
sophistication. Other topics are more introductory in nature to enable the
motivated general reader to have a grasp of the financial world.
Hopefully, the basic discussion will stimulate them to explore the more
sophisticated issues which have emerged in recent years.
Several persons have played an important role in initiating the idea and
bringing it to fruition. The encouragement, enthusiasm and diligence of
Butterworths' editorial staff have played an important cementing role in
bringing numerous contributors together to work on a common project.
The cheerful but persuasive reminders from Miss Yap Choo Lian of the
Dean's Office, Faculty of Business Administration have been greatly
appreciated.
Tan Chwee Huat
Kwan Kuen-Chor
National University of Singapore
October 1988
ν
Contributors
Ang Kong Hua BSc(Econs) (Hons), President of Transtech Venture
Management Pte Ltd, Managing Director of National Iron & Steel Mills
Ltd., Singapore.
Chia Kay Guan, Robert BA MA PhD, Senior Lecturer, Department of
Finance and Banking, Faculty of Business Administration, National
University of Singapore.
Chua Joon Eng Cert Ed, BA(Hons) MBiA, Senior Lecturer, Department
of Finance and Banking, Faculty of Business Administration, National
University of Singapore.
Foo, Wendy BSc ACA FCA, Senior Lecturer, School of Accountancy,
Nanyang Technological Institute.
Gn Hiang Lin BBA(Hons), Senior Tutor, Department of Decision
Sciences, Faculty of Business Administration, National University of
Singapore.
Hua Pak Cheong BSc(Econs) (Lond), Cert Ed, Cert Business Studies,
FAIB MSIPM, Training and Development Manager of Standard Char-
tered Bank, Singapore.
Koh Cher Chiew, Francis BBA(Hons) MBA PhD, Senior Lecturer,
Department of Finance and Banking and Vice Dean, Faculty of Business
Administration, National University of Singapore.
Koh Seng Kee BBA(Hons), Senior Tutor, Department of Finance and
Banking, Faculty of Business Administration, National University of
Singapore.
Ê wan Kuen-Chor BSocSc MBA PhD, Senior Lecturer, Department of
Finance and Banking, Faculty of Business Administration, National
University of Singapore.
Mohamed Ariff BSocSc(Hons) MBA PhD, Senior Lecturer, Department
of Finance and Banking, Faculty of Business Administration, National
University of Singapore.
xi
xii Contributors
Pointon, Leo BA MA LLM FBIM AFNZIM MUM ACIArb PhD, Senior
Teaching Fellow, School of Accountancy, Nanyang Technological Insti-
tute.
Srinivasan, S BSc MSc MS PhD, Senior Lecturer, Department of
Decision Sciences, Faculty of Business Administration, National Univer-
sity of Singapore.
Ta Huu Phuong BSc(Hons) MSc PhD, Associate Professor and Head,
Department of Decision Sciences, Faculty of Business Administration,
National University of Singapore.
Tan Chwee Huat BAcc(Hons) MBA MSc PhD, Dean, Faculty of Business
Administration and Head, Department of Finance and Banking,
National University of Singapore.
Tan Soo Jiuan BBA(Hons), Senior Tutor, Department of Finance and
Banking, Faculty of Business Administration, National University of
Singapore.
Tew Kim Chuan BSc(Hons) MBA MS, Assistant Vice-President and
Assistant Regional Representative of Swiss Bank Corporation, Singa-
pore.
Wong Kie Ann BCom MCom PhD, Senior Lecturer and Deputy Head,
Department of Finance and Banking, Faculty of Business Administra-
tion, National University of Singapore.
Chapter 1
The Corporate Funding Decision
Chua Joon Eng
1.01 Introduction
This book is primarily concerned with the acquisition of funds by
corporations - one of the key responsibilities of corporate management.
It examines the various options available for funding a company's needs
and discusses the usefulness of these options and the problems associated
with them. It also outlines the nature and characteristics of the
institutions involved in providing short- and long-term finance to
Singapore and Malaysian companies as well as the techniques and the
laws involved in tapping those sources of finance.
Besides concerning itself with domestic sources of corporate funding,
this book also deals with various aspects of international finance. It gives
a brief outline of the international financial system and discusses in
depth the various instruments of international trade finance and the
problems, risks and mechanics associated with using these instruments.
This book also provides some guidelines to corporate financial officers
who have to manage the foreign exchange transactions of their firms and
deal with corporate taxes across national boundaries.
This book is written primarily for those who have or hope to be given
treasury responsibilities in medium-sized and major companies within
Asean involved in international business as well as those who either wish
to invest in or have dealings with companies in the Asean region, as the
purpose of this book is to detail those aspects of the Singapore and
Malaysian financial systems which relate to corporate funding and
finance - a proper understanding of which is critical for those involved in
making financing and investment decisions in the region. Without this
proper understanding, it will be difficult if not impossible to make
rational and objective decisions.
The emphasis throughout this book is one of practical utility to
managers involved in corporate financial management. This book is
therefore less concerned with theoretical issues and more concerned with
1
2 The Corporate Funding Decision
the instruments, institutions and mechanics involved in obtaining funds
to support the activities of Singapore and Malaysian enterprises.
The purpose of this chapter is to describe a framework within which
corporate funding questions can be analysed and to indicate the
considerations which determine the corporate financial managers' choice
of funding alternatives.
1.02 Financial Objectives of the Firm
The financial manager of a company has a number of tasks. Broadly
speaking, most of these tasks fall under two categories:
(1) the allocation of funds to specific assets, and
(2) the raising of funds both externally and internally.
The sources of funds for the financial manager are many: trade creditors,
commercial banks, merchant banks, finance companies, insurance com-
panies, factoring and leasing companies and investors in the company's
stock. The funds obtained from these sources are invested by the
financial manager in marketable securities, accounts receivable owed by
customers, inventories to facilitate production and sales, and fixed assets
used in the production of goods or the provision of services. This flow of
funds from sources to uses is the product of the decisions made by the
financial manager, taking into account the financial objectives of the
firm.
Although a number of objectives can be advanced, most writers agree
that the primary objective of the firm is to direct activities to maximize
stockholders' wealth or the value of the firm. This objective can be
achieved by the maximization of profits or return on investment (ROI)
subject to an acceptable level of risk.
The reasons why writers agree that maximization of stockholders'
wealth or the value of the firm should be the primary objective of the firm
include the following:
(1) stockholders invest in the firm because they want to maximize their
return on investment over the long-term and minimize their risks;
(2) corporate managers are paid by stockholders to manage the corpora-
tion and they therefore have an obligation to help the stockholders
achieve their objectives;
(3) maximization of stockholders' wealth or the value of the firm:
(a) is a goal that takes into account returns and risks associated with
an investment and a financing decision, including the timing of
such returns, and
(b) leads to efficient allocation of resources.
Although, in practice, managers may not be able to achieve this objec-
tive fully because of a number of constraints, this goal is still
advanced as the ideal goal of all corporate financial decisions. This is
because we are considering the basis for making rational financial
decisions and not attempting to explain the nature and character of
financial decisions currently made by the financial managers. Further-
The Basic Issue: Returns and Risks 3
more, this goal will result in the maximization of the market price of the
firm's stock which serves very well as a performance index of the firm's
progress; it indicates how well management is doing on behalf of the
stockholders.
It should, however, be noted that maximization of stockholders'
wealth is not advanced as the only guide to management action, for
certainly other considerations should and do impinge on the firm's
decision-making process. However, we do emphasize that this should be
the primary objective.
1.03 The Basic Issue: Returns and Risks
Major decisions made by a firm include:
(1) investment decisions, ie decisions concerning the allocation of
capital to specific assets whose benefits are to be realized in the
future;
(2) financing decisions, ie decisions concerning the best capital structure
of the firm; and
(3) dividend decisions, ie decisions concerning the percentage of earn-
ings to be paid to the stockholders in cash dividends, the stability of
absolute dividends over time and the repurchase of stock.
These major categories of decisions determine the returns and risks
associated with the firm and also the value of the firm. If the firm makes
good investment, financing and dividend decisions, its returns as well as
its value will increase. On the other hand, if the firm makes a poor
decision in one or more of these areas, the market price of its stock will
fall and its value will not be maximized.
Making good investment decisions means that the firm has to invest in
profitable projects which carry minimum risks. This, however, is easier
said than done for projects which give high rates of return are often those
which are the most risky. On the other hand, if the firm is contented with
a lower rate of return it needs to take lower risks. In making financial
decisions, therefore, the firm needs to assess the appropriate trade-off it
wants to achieve between returns and risks.
The risks faced by a firm are numerous. They include risks resulting
from changes in the following: economic and social environment,
political-legal decisions made by governments, technology, and the tastes
of consumers. These risks can be categorized broadly into two types:
(1) business risks, and
(2) financial risks.
By business risks, we mean the risks resulting from the firm's choice of
business activities and past investment decisions. Since different lines of
business entail different risk characteristics because of the differing rates
of growth, technological requirements and production costs, etc, a firm
that is engaged in a certain line of business faces similar risks as those
faced by other firms in the same industry. A firm can, therefore, change
the nature of its business risks only by changing its line of business
partially or completely.
4 The Corporate Funding Decision
By financial risks, on the other hand, we mean the risks faced by the
firm as a result of the way it finances its business activities. The financial
risks faced by a firm are therefore determined by the firm's financial
policies, foremost of which is its decision regarding its capital struc-
ture - the proportion of debt and equity funds employed. By using debt
funds to finance its operations, a firm can increase its expected returns to
its stockholders but this increased borrowing exposes the firm to a greater
degree of insolvency as the firm's earnings may not be sufficient to meet
interest payments and principal repayments. A firm can, therefore, alter
the nature of the financial risks it faces by changing its capital structure
either by raising more equity capital through the issue of shares, reducing
its loans or increasing its retained earnings.
In attempting to maximize the value of the firm or stockholders'
wealth, a balance must be achieved between the need for a high rate of
return and the need for lower risks. In attempting to achieve this balance,
a firm's chosen financial policy should not increase unduly the risks to
which the firm is exposed even if the policy promises to maximize profits
under normal conditions, for policy this will not be regarded as an
optimal decision.
1.04 Short-Term Funding Decision:
Current Liability Management
To maximize stockholders' wealth, a financial manager has not only to
invest the firm's funds profitably, but he also has to make appropriate
funding decisions. This involves making decisions regarding:
(1) the capital structure of the firm, ie the proportion of the firm's debt
capital and equity capital;
(2) the proportion of the firm's short- and long-term debt; and
(3) the appropriate level of off-balance sheet financing for the firm.
In this section, we will discuss some of the considerations that a financial
manager takes into account in deciding on the best proportion of short-
and long-term debt, and leave the question regarding the capital structure
of the firm to the next section.
To a large extent, the proportion of a firm's short- to long-term debt is
determined by the nature of the firm's business. For example, retail firms
which generally carry a large volume of inventory relative to manufactur-
ing firms can be expected to have a larger amount of accounts payable. It
will be larger simply because larger inventories lead to larger accounts
payable. So a major factor influencing a firm's level of current liabilities
or short-term debt is its level of inventory and other current assets. Other
things being equal, businesses requiring high levels of current assets tend
to have a fairly high level of current liabilities, ie a larger proportion of
short-term debt to long-term debt.
Another element influencing the proportion of short-term debt
employed is the degree of flexibility desired by the firm. Flexibility, in
this context, has two aspects. First, generally, a firm that uses a high
proportion of short-term debt to finance its activities will find it difficult
Short-term Funding Decision 5
to raise additional short-term debt should the need arise suddenly.
Second, there is greater flexibility in using short-term debt because of the
ease with which these funds can be raised if the firm has not fully utilized
its short-term borrowing capacity; the processing time for short-term
debt is much shorter than for long-term credit. A third factor which
influences the proportion of short- and long-term debt used is the relative
costs of the different types of debt finance. In general, long-term debt
usually costs more than short-term debt because:
(1) long-term interest rates are normally higher than short-term rates;
(2) long-term debt involves flotation or placement costs which are not
normally found in short-term debt; and
(3) early repayment of long-term debt may involve prepayment
penalties.
Although the factors determining the extent of the firm's use of short-
term debt are numerous, the primary consideration is the risk-return
trade-off associated with the appropriate mix between short- and long-
term financing required to fund the firm's current asset investments. For
example, a firm may decide to increase its proportion of short-term debt
relative to long-term sources of finance and its profitability or return on
investment; however, this can be achieved only by the firm facing a
higher degree of insolvency. This is clearly illustrated below:
Conservative policy Aggressive policy
Current assets $ 64,000 $ 64,000
Fixed assets 144,000 144,000
$208,000 $208,000
Accounts payable $ 18,000 $ 18,000
Notes payable (11%) 0 40,000
Current liabilities $ 18,000 $ 58,000
Long-term debt (15%) 40,000 0
Equity 10,000 shares 150,000 150,000
Total claims $208,000 $208,000
Net operating income $116,000 $116,000
Interest expense 6,000 4,400
Earnings before income tax $110,000 $111,600
Taxes (50%) 55,000 55,800
Net income $ 55,000 $ 55,800
Earnings per share $ 5.50 $ 5.58
Rate of return on equity 36.7% 37.2%
In the above example, the aggressive policy adopted increases the return
for the firm as measured by earnings per share and rate of return on
equity. This, however, has been achieved at the cost of increased risk as
measured by the current ratio and the net working capital:
Conservative policy Aggressive policy
Current ratio 3.55 1.10
Net working capital $46,000 $6,000
In deciding the appropriate mix between short-term and long-term debt,
the firm therefore needs to decide on the appropriate trade-offs it wants,
given the risk preferences of the firm's managers.
