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CHAPTER 25:
SOURCES OF LONG-TERM
FINANCING
SOURCES OF CAPITAL FOR BUSINESS FIRMS
Suppliers of Debt Financing Suppliers of Equity
Financing
TERM LOANS
• COMMON
CHARACTERISTICS
a) Have maturities of more than
1 to 10 years
b) are repaid in periodic
installments over the life of the
loan
c) Are usually secured by a
chattel mortgage on
equipment or a mortgage on
real property
MATURITY
the agreed-upon date on which the
investment ends, often triggering the
repayment of a loan or bond, the payment
of a commodity or cash payment, or some
other payment or settlement term.
.
DEBT FINANCING
ADVANTAGE
1. Interest payments are tax-
deductible
2. The financial obligation is clearly
specified and of a fixed nature
3. Inflationary Economy may be
paid back with cheaper peso
4. Use of debt up to a prudent point
may lower its capital to the firm
DISADVANTAGE
COLLATERAL
• an item of value pledged to
secure a loan. Collateral reduces
the risk for lenders. If a borrower
defaults on the loan, the lender
can seize the collateral and sell it
to recoup its losses. Mortgages
and car loans are two types of
collateralized loans.
RESTRICTIVE COVENANTS
• clauses that prevent, prohibit,
restrict, or limit the actions of a
person or entity named in a
contract. Restrictive covenants
are common in real estate
transactions and apply to
everything from the colors you
can paint your house to how
many tenants can live in a
building.
REPAYMENT
SCHEDULE
• the act of paying back money
previously borrowed from a
lender. Typically, the return of
funds happens through
periodic payments, which
include both principal and
interest. The principal refers to
the original sum of money
borrowed in a loan.
BONDS
TRADING PROCESS FOR CORPORATE BONDS
• can be bought and sold in the
“secondary market” after they are
issued. While some bonds are traded
publicly through exchanges, most
trade over-the-counter between large
broker-dealers acting on their clients'
or their own behalf.
FIRM COMMITMENTS UNDERWRITING OF A CORPORATE
BOND
Competitive sale
Negotiated sale
Best efforts underwriting basis
Bond features and prices
PAR VALUE
COUPON INTEREST RATE
MATURITY
INDENTURE
CURRENT YIELD
YIELD TO MATURITY
FORMULA:
𝐴𝑝𝑝𝑟𝑜𝑥𝑖𝑚𝑎𝑡𝑒 𝑦𝑖𝑒𝑙𝑑 𝑡𝑜 𝑚𝑎𝑡𝑢𝑟𝑖𝑡𝑦 =
𝑎𝑛𝑛𝑢𝑎𝑙 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡
𝑝𝑎𝑦𝑚𝑒𝑛𝑡
+ 𝑝𝑟𝑖𝑛𝑐𝑖𝑝𝑎𝑙 𝑝𝑎𝑦𝑚𝑒𝑛𝑡 − 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑡ℎ𝑒 𝑏𝑜𝑛𝑑
.6 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑡ℎ𝑒 𝑏𝑜𝑛𝑑 + .4(𝑝𝑟𝑖𝑛𝑐𝑖𝑝𝑎𝑙 𝑝𝑎𝑦𝑚𝑒𝑛𝑡)
Credit Quality Risk
It is a chance that the
bond issuer will not be
able to make timely
payments.
BOND RATINGS
Involve judgment about
the future risk potential of
the bond provided by
rating agencies.
Credit Ratings
TYPES OF
BONDS
UNSECURED LONG-TERM BONDS
Debentures
Subordinated Debentures
Income bonds
B. SECURED LONG-TERM BONDS
• First mortgage bonds
Mortgage Bonds
b) Second mortgage bonds
c) Blanket or general Mortgage
bonds
d) Closed-end mortgage bonds
e) Open-end mortgage bonds
f) Limited Open-end mortgage
bonds
Other types of
Bonds
FLOATING RATE OR VARIABLE
BONDS
JUNK OR LAW-BONDS
EURO BONDS
TREASURY BONDS
METHODS OF RETIRING DEBT
SERIAL
PAYMENTS
CONVERSION CALL
PROVISION
BOND
REFUNDING
PREFFERED
SHARE
a type of security that offers
characteristics similar to both common
shares and a fixed-income security. The
holders of preference shares are typically
given priority when it comes to any
dividends that the company pays.
PREFERRED
SHARE FEATURES
1. PAR VALUE
2. DIVIDENDS
3. CUMULATIVE AND NON CUMULATIVE
DIVIDENDS
4. NO DEFINITE MATURITY DATE
5. CONVERTIBLE PREFERRED SHARE
6. VOTING RIGHTS
7. PARTICIPATING RIGHTS
8. PROTECTIVE FEATURES
9. CALL PROVISON
10. MATURITY
Advantages and disadvantages of financing
with preferred value
ADVANTAGES
1. FINANCING FLEXIBILITY
2. FAVORABLE FINANCIAL
LEVERAGE
3. NO DILUTION OF CONTROL
4. NO MATURITY
5. ASSET PRESERVATION
6. NO EQUAL PARTICIPATION IN
EARNINGS
DISADVANTAGES
1. HIGH COST
2. SENIORITY OF THE HOLDER’S
CLAIM
PREFERRED
SHARE
VALUATION
ORDINARY
EQUITY
SHARE
Features of Ordinary
Equity shares
1. PAR VALUUE/ NO PAR VALUE
2. AUTHORIZED, ISSUED AND OUTSTANDING
3. NO MATURITY
4. VOTING RIGHTS
5. BANK VALUE PER SHARE
6. NUMEROUS RIGHTS OF STOCK HOLDER
2 COMMON SYSTEMS OF VOTING
MAJORITY
VOTING
CUMULATIVE
COMPARATIVE
FEATURE OF
ORDINARY EQUITY
SHARES,
PREFERRED
SHARES AND DEBT
ORDINARY EQUITY SHARES OVER
PREFERRED SHARES AND BOND
ADVANTAGES
1. No mandatory fixed charges
2. No definite maturity date
3. Potentially greater ease of sale
4. Increased creditworthiness
5. Avoidance of restrictive provisions
6. From a social view points
DISADVANTAGES
1. Dilution of Control and Earnings
2. Higher issue cost
3. Cause increase in component
cost of capital

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capital-chapter25-1.pptx

  • 1. CHAPTER 25: SOURCES OF LONG-TERM FINANCING
  • 2. SOURCES OF CAPITAL FOR BUSINESS FIRMS Suppliers of Debt Financing Suppliers of Equity Financing
  • 3. TERM LOANS • COMMON CHARACTERISTICS a) Have maturities of more than 1 to 10 years b) are repaid in periodic installments over the life of the loan c) Are usually secured by a chattel mortgage on equipment or a mortgage on real property
  • 4. MATURITY the agreed-upon date on which the investment ends, often triggering the repayment of a loan or bond, the payment of a commodity or cash payment, or some other payment or settlement term. .
  • 5. DEBT FINANCING ADVANTAGE 1. Interest payments are tax- deductible 2. The financial obligation is clearly specified and of a fixed nature 3. Inflationary Economy may be paid back with cheaper peso 4. Use of debt up to a prudent point may lower its capital to the firm DISADVANTAGE
  • 6. COLLATERAL • an item of value pledged to secure a loan. Collateral reduces the risk for lenders. If a borrower defaults on the loan, the lender can seize the collateral and sell it to recoup its losses. Mortgages and car loans are two types of collateralized loans. RESTRICTIVE COVENANTS • clauses that prevent, prohibit, restrict, or limit the actions of a person or entity named in a contract. Restrictive covenants are common in real estate transactions and apply to everything from the colors you can paint your house to how many tenants can live in a building.
  • 7. REPAYMENT SCHEDULE • the act of paying back money previously borrowed from a lender. Typically, the return of funds happens through periodic payments, which include both principal and interest. The principal refers to the original sum of money borrowed in a loan.
  • 8. BONDS TRADING PROCESS FOR CORPORATE BONDS • can be bought and sold in the “secondary market” after they are issued. While some bonds are traded publicly through exchanges, most trade over-the-counter between large broker-dealers acting on their clients' or their own behalf.
  • 9. FIRM COMMITMENTS UNDERWRITING OF A CORPORATE BOND Competitive sale Negotiated sale Best efforts underwriting basis
  • 10. Bond features and prices PAR VALUE COUPON INTEREST RATE MATURITY INDENTURE CURRENT YIELD YIELD TO MATURITY
  • 11. FORMULA: 𝐴𝑝𝑝𝑟𝑜𝑥𝑖𝑚𝑎𝑡𝑒 𝑦𝑖𝑒𝑙𝑑 𝑡𝑜 𝑚𝑎𝑡𝑢𝑟𝑖𝑡𝑦 = 𝑎𝑛𝑛𝑢𝑎𝑙 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑝𝑎𝑦𝑚𝑒𝑛𝑡 + 𝑝𝑟𝑖𝑛𝑐𝑖𝑝𝑎𝑙 𝑝𝑎𝑦𝑚𝑒𝑛𝑡 − 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑡ℎ𝑒 𝑏𝑜𝑛𝑑 .6 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑡ℎ𝑒 𝑏𝑜𝑛𝑑 + .4(𝑝𝑟𝑖𝑛𝑐𝑖𝑝𝑎𝑙 𝑝𝑎𝑦𝑚𝑒𝑛𝑡)
  • 12. Credit Quality Risk It is a chance that the bond issuer will not be able to make timely payments. BOND RATINGS Involve judgment about the future risk potential of the bond provided by rating agencies.
  • 14. TYPES OF BONDS UNSECURED LONG-TERM BONDS Debentures Subordinated Debentures Income bonds B. SECURED LONG-TERM BONDS • First mortgage bonds Mortgage Bonds
  • 15. b) Second mortgage bonds c) Blanket or general Mortgage bonds d) Closed-end mortgage bonds e) Open-end mortgage bonds f) Limited Open-end mortgage bonds
  • 16. Other types of Bonds FLOATING RATE OR VARIABLE BONDS JUNK OR LAW-BONDS EURO BONDS TREASURY BONDS
  • 17. METHODS OF RETIRING DEBT SERIAL PAYMENTS CONVERSION CALL PROVISION BOND REFUNDING
  • 18. PREFFERED SHARE a type of security that offers characteristics similar to both common shares and a fixed-income security. The holders of preference shares are typically given priority when it comes to any dividends that the company pays.
  • 19. PREFERRED SHARE FEATURES 1. PAR VALUE 2. DIVIDENDS 3. CUMULATIVE AND NON CUMULATIVE DIVIDENDS 4. NO DEFINITE MATURITY DATE 5. CONVERTIBLE PREFERRED SHARE 6. VOTING RIGHTS 7. PARTICIPATING RIGHTS 8. PROTECTIVE FEATURES 9. CALL PROVISON 10. MATURITY
  • 20. Advantages and disadvantages of financing with preferred value ADVANTAGES 1. FINANCING FLEXIBILITY 2. FAVORABLE FINANCIAL LEVERAGE 3. NO DILUTION OF CONTROL 4. NO MATURITY 5. ASSET PRESERVATION 6. NO EQUAL PARTICIPATION IN EARNINGS DISADVANTAGES 1. HIGH COST 2. SENIORITY OF THE HOLDER’S CLAIM
  • 23. Features of Ordinary Equity shares 1. PAR VALUUE/ NO PAR VALUE 2. AUTHORIZED, ISSUED AND OUTSTANDING 3. NO MATURITY 4. VOTING RIGHTS 5. BANK VALUE PER SHARE 6. NUMEROUS RIGHTS OF STOCK HOLDER
  • 24. 2 COMMON SYSTEMS OF VOTING MAJORITY VOTING CUMULATIVE
  • 25.
  • 27. ORDINARY EQUITY SHARES OVER PREFERRED SHARES AND BOND ADVANTAGES 1. No mandatory fixed charges 2. No definite maturity date 3. Potentially greater ease of sale 4. Increased creditworthiness 5. Avoidance of restrictive provisions 6. From a social view points DISADVANTAGES 1. Dilution of Control and Earnings 2. Higher issue cost 3. Cause increase in component cost of capital