Question

QUESTION 1

1. Fueltech Company, a biotech research and development firm started ten years ago, has had operating losses since its origin. Today, the firm has a number of products in the development pipeline that management believes have prospects for commercial application at some unknown time in the future. The firm has no long-term debt. When it was started, management decided to finance operations with common stock sales to the founders and a small group of private investors.

As an outside consultant, would you advise management to raise financing now through the sale of long-term bonds? Explain your answer so that management, whose expertise is in science and not finance, can easily understand it.     

Answer 1

As of now, I will not advise the management of the firm to raise funds through debt, this is because:

1. Debt will lead to mandatory periodic interest payments and scheduled repayments. While the future of the products still uncertain, the cash inflows of the project are uncertain. Hence, we will be tied up in a situation where liability is fixed and certain while inflows are not.
2. We should not try to match uncertain inflows with certain outflows.
3. At times, cash flows may not be sufficient enough to service the debt.
4. Hence, the company's cash flows are neither stable nor uniform nor certain to handle debt servicing.

Hence, the management should not raise funds through debt.