Knowledge Holdings Limited

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Content
Content.................................................................................................... 1
1.0 Introduction...............................................................................................2
2.0 Sources of finance......................................................................................2
2.1 Issued of debts...................................................................................2
2.2 Issued of new ordinary shares: ....................................................4
2.3 Issued of new preference shares:.....................................................5
3.0 Assess on the costs of various sources of finance ...................................7
Appendix................................................................................................. 9
References............................................................................................. 10
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Website: Email : Tel : 0918.775.368
Knowledge Holdings Limited
Date:
To: Board of directors
Capital (US $ 27 million) structure proposal report
1.0 Introduction
Knowledge Holding Limited is a publicly listed company in New York Stock Exchange since
2001. Knowledge Holding Limited’s core business is in books-retailing related business.
Knowledge Holding Limited has over 200 mega-size bookstores located in Europe, Asia-pacific
region, North American region, and United States. The company’s directors believe in their
business in Vietnam because of some opportunities. First, Vietnam is one of the youngest
populations in the world. The youngster is fond of reading book and thirsty for knowledge as
well as quality books. Second, there has been increasing foreigners in Vietnam and their
demand for quality books is high. Third, Vietnam government has many incentive policies for
foreign business enterprises and Vietnam’s entry in to WTO in 2007 provides the necessary
advantage for the company. The plan of the company is having no less than 12 mega-size
bookstores in the various metropolis cities of Vietnam in the next four years. The business
expansion plan faces capital challenges. The company needs at least US$ 27million dollars.
There are various alternative sources of finance available to Knowledge Holding Limited. The

basic sources of finance comprise equity and debt. Preference shares and ordinary shares are
two kind of equity. Retained earnings and issue of new shares are two ways of investment after
paying preference dividend and ordinary dividend. Short-term debt and long-term debt are two
kinds of debt.
2.0 Sources of finance
2.1 Issued of debts
Debt financing: When a firm raises money for working capital or capital expenditures
by selling bonds, bills, or notes to individual and/or institutional investors. In return for lending
the money, the individuals or institutions become creditors and receive a promise that the
principal and interest on the debt will be repaid.
( )
Interest expense is tax-deductible because interest expenses do affect the taxes payable.
If the company borrows more money from debt holders, the company will incur more interest
expenses; therefore, taxes payable will reduce. If company borrows less, the interest expense
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will be less and the taxes payable will increase. In short, with debt, the company will incur
higher interest expense, but this being reduced by tax savings
The after- tax cost of debt, kd (1-T), is used to calculate the weighted average cost of
capital, and it is the interest rate on debt, kd, less the tax savings that result because interest is
deductible. This is the same as kd multiplied by (1-T), where T is the firm’s marginal tax rate
After-tax component cost of debt = Interest rate - Tax savings
= kd - kdT
= kd (1-T)
Based on the formula above, the higher tax rate, the lower cost of debt, therefore the
company should issue more debt. The lower tax rate, the higher cost of debt, the company
should issue less debt. The present tax rate is 30%, the cost of debt after tax rate is 5, 6%. The
corporate tax rate for foreign is expected to go down, hence, the tax rate will decrease and the
cost of debt after tax will increase. For that reason, the company should issue less debt.
Control implication

Knowledge Holding Limited is majority owned (52% stake) by her Chief Executive
Officer (CEO), Mr Stanmore. Mr Stanmore has effective control in the company because his
stake is more than 50%. He has the highest voting rights in the company. Every company’s
business decisions have to be made with the acceptations of Mr Stanmore. Definitely, Mr
Stanmore does not want to share his voting rights with other people. Issued of new debts is a
way for companies to raise capital without giving up ownership in their company because of
debt holders having non- voting right.
Risk implication:
In the event of winding up the company, debt holders will have the first claim on
company’s assets. Shareholders will bear the financial risk which is the additional risk as a
result of the decision to finance with debt. If the company’s business are not well , the company
still have to pay interest rate for debt holders If the company issued debt, the company have to
incur business risk which is inherent in a business for any companies as well as financial risk
;debt holder does not have to bare any of the business risk. Because interest expenses which the
company have to pay for debt holder are fixed.
Legal implication
Interest payments are mandatory. If bankruptcy occurs, the debenture holders are considered
creditors and must be paid back by the companies remaining assets. Shareholders do not have to
share their profits if the business is extremely successful.
Financial cost implication:
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K
e
d
= 5, 6 %
Tax rate = 30%
K
d
= 8%

Because interest is a deductible expense, it produces tax savings which reduce the net cost of
debt, making the after-tax cost of debt less than before tax cost. With debt, the company will
incur higher interest expense, but this being reduced by tax savings
2.2 Issued of new ordinary shares:
Taxes implication
Ordinary dividends are not tax-deductible because ordinary dividends are paid out from the
earnings after taxes. Thus, tax adjustment is not required when estimating the cost of ordinary
shares. There is an advantage of issue new ordinary shares: payment of ordinary dividends is at
the discretion of the company, therefore, ordinary dividends are variable.
Control implication:
Stake is ownership in an enterprise that one company acquires in another that represents less
than 100 percent ownership. The stake holders have voting right in making business decisions
of company. The more percent of stake stakeholders owned, the more voting right they have. In
Knowledge Holding Limited Company, the CEO owned 52% stake. He has the most controlling
stake. If the company issue ordinary shares, CEO’s stake and other existing shareholders’ stake
will be diluted.
Risk implication: Knowledge Holding Limited faces with both financial risk and business risk.
If the company is wound up, ordinary shareholders’ voting right will rank after debt holder and
preference shareholders respectively on the claims of company’s assets on liquidation. That is
financial risk of issue ordinary shares. The business risk is uncertainty in the projection of
future operating income. In Vietnam, fake-books and contraband books are quite familiar. That
is an disadvantage that lead to business risk for the company to penetrate in Vietnam market.
Issue of new ordinary shares will send a negative “signal” to investors.
Legal implication:
Ordinary shareholders and CEO will propose the ordinary dividends pay-out. The ordinary
dividends in common does not stable because the company earnings fluctuate from year to year.
The shareholders have the right to share in the company's profits. The more money the company
has left after it has paid all its debts, the more shareholders
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share of the company will be worth. It is not mandatory for the company to pay ordinary
dividends. If the company fails, shareholders could lose all of their investment. When a
bankrupt business is wound up, shareholders are last in line to get money out of what is left.
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Financial cost implication:
The factors which are influence the cost of ordinary shares are ordinary dividends, ordinary
issued price, flotation and growth rate in earnings.
Earnings per share (EPS) are equal to earnings available to shareholders divided by
number of outstanding shares. When the company issues ordinary share, the earning available
to shareholders will remain but the number of outstanding shares will increase. Therefore,
(ESP) will be diluted. If the company has profitable projects and it is costly to raise funds, it
may decide to retain the earnings
2.3 Issued of new preference shares:
Beginning with Tax implication : preference dividends are paid out from the earnings
after taxes. Hence, preference dividends are not tax deductible. A tax adjustment is not required
when estimating the cost of preference shares because there is not tax saving here. The
preference share price (P
p
) is $54, preference share’s flotation cost (F
p
) is 6%, and constant
preference dividend (D
p
) is $4 per year. Applying to the formula, the cost of preference share
(K
p
) is 7.88%.
About the control implication of issued of preference shares, ordinary shareholders’
stakes would not be diluted that is because the preference shareholders have no voting rights in
the company. As a result, 52% stake by CEO will be maintained when the company issued of

preference shares.
Risk implication: Preference dividends are paid out after paying interest expenses. That
is financial risk to preference shareholders if the company’s business operation is not good. To
deal with the risk, the company has to support preference shareholders with legal obligations.
“If the company goes bankrupt, you'll likely lose money on your preferreds, but likely less
money than if you'd bought the firm's common stock. Preferreds entitle you to a set amount of
money if the company goes bust. However, you'll only be paid after bond holders and other
creditors have been paid, which might mean there won't be much left”.
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