T3 Corporate Financing Flashcards
Corporate Investment
Corporations invest in long term assets (machinery)& current assets (inventory)
Internal funding is more convenient than external because
Avoid costs of issuing new securitys or negotiating debt
When managers are too adverse to external funding they tend to rely on internal funds
Debt ratio =
Proportion of debt relative to the firm value
value of debt/ value of debt + value of shares
Value of debt =
current liabilities + long term liabilities
Difference between book and market value
Book value - how much capital the firm has raised from shareholders in the past
Market value - value that shareholders place on those today
The market value of equity often larger than book value of equity but market debt ratio often lower than book debt ratio
A corporation is owned by its common stockholders
They can raise new cash by issuing new stock
Stocks held by investors are called issued and outstanding
Stocks that are bought back from investors are called issued but not outstanding
Common stock and ownership
Shareholders have residual cash flow rights
The privileged rights go to lenders of the firm e.g. banks
Shareholders have residual control rights over the firms affairs e.g. investment decisions
In many firms control is limited to voting in case of bankruptcy
Voting procedures
Many decisions requite a majority vote or a supermajority (75%)
2 types of shares
Common Stock - do not receive dividends until preferred stock, do not give ownership right unless company fails to pay preferred dividend
Preferred Stock - dividend rate fixed at time of issue and given priority over common stock when receiving dividends. Superior voting power so sell at premium - larger private benefits - toss out bad management, bargaining power, challenge positions
Should the company borrow short term (bank loan) or long term (bonds)?
Depends on time horizon of project. Temporary increase in inventories take out short term bank loan
Cash needed to pay for expansion of new building issue long term bonds
Should the Interes rate on loans be fixed or floating?
Normally bank loans are floating rates. Sterling Overnight Index Average)
Bonds carry fixed payments (coupons)
Should company borrow in domestic or foreign currency?
Depends on whether company has overseas operations.
What promises should be made to the lender?
Depends on lenders concern about risk associated with the loan. Lenders may demand debt is senior (safer). Firms may set aside some of its assets (collateral) for protection of particular creditors. If firm defaults on loan bank can seize collateral.
Should issue straight or convertible bonds?
Convertible bonds gives owner option to exchange bond for a predetermined number of shares
Depends on expectations of firms share price
Increase - convert bond with profit
Decrease - no obligation to convert
Financial Markets
Financial assets are issued by corporations (primary market) & traded by investors (secondary market) regularly trade on stock exchange or OTC markets
Financial Intermediaries
raise money from investors & provide financing for individuals
