WEEK 4 - Corporate Financing Flashcards
(47 cards)
How do companies finance their investment?
Via internal funds (Profits, Depreciation) and external funds (New Equity,Borrowing)
How much does internal funding make up in overall corporate financing in Germany, Japan and the UK?
More than 2/3 in Japan,Germany and UK
Why is internal funding more convenient than external?
- Avoids the cost of issuing new securities or negotiating debt
- Shareholders happy if retained profits finance positive NPV projects (forgo dividends but stock has greater market value)
What is the downside of a reliance on internal financing?
Losing risky but positive NPV projects
How do you measure a companies debt?
Via the debt ratio
Which is the proportion of debt relative to the firm value
How do you calculate Debt Ratio?
Value of Debt / Value of Debt +Value of Shares
What is the Book Value?
Tells us how much capital the firm has raised from shareholders in the past (Accounting Value)
What is the Market Value?
Measures the value that shareholders place on those shares today
What is the truth behind the market value and book value of equity?
The market value of equity is often much larger than book value of equity
The market debt ratio often much lower than the book debt ratio
What are stocks and shares held by investors called?
Issued and outstanding shares/stocks
What are stocks and share bought back from investors called?
Issued but not outstanding shares/stocks
What is common stock?
shares that can be bought by common shareholders
What do shares refer to?
Refers to the ownership certificates of a particular company
What do stocks refer to?
Refers to the ownership certificates of any company
i.e To the overall ownerships in one or more companies
What kind of rights do regular shareholders have?
- Residual cash flow rights
- Residual control rights over firm’s affairs - Usually in widely held companies common shareholder stock limited or restricted to individual entitlement to vote i.e 1 share = 1 vote
How do the voting procedures usually work?
- Shareholders vote
- Many require simple majority
- Some decisions require supermajority (75% of those eligible to vote) (e.g. mergers)
How can companies change the classification of shares?
May have two classes of stock outstanding which differ in their right to vote
e.g Facebook releasing class A stocks (sold to public 1 share= 1 vote) and Class B stocks (1 share = 10 votes, held by founders)
Why do stocks with superior voting power sell at a premium?
- Greater control rights grant larger private benefits
i. e. - Prevent challenge to his/her management position
- extra bargaining power in an acquisition
- secure a business advantage
- toss out bad management or force management to adopt policies that enhance shareholder value (these can also benefit all shareholders)
What is a preferred stock?
Entitles the holder to a fixed dividend (fixed on time of issue), whose payment takes priority over that of ordinary share dividends.
- Do not grant ownership rights unless company fails to pay preferred stock then some voting rights
What is the standard procedure when companies borrow money?
Promise to make regular interest payments and repay the principle (Limited Liability
What is the unique feature of Debt for companies?
Borrowers can away from obligation to pay (i.e default) in exchange for assets of company.
Willing to do so if: Value of Assets < Value of Debt
Not straightforward -> Bankruptcy process
What is a default risk?
term used to describe the likelihood that a firm will walk away from its obligation, voluntarily or involuntarily.
Why are bond ratings issued on debt instruments?
To help investors assess the default risk of a firm
What are some of the elements of holding debt (i.e. company owning you money)
Debt claim on cash flows is limited (to the interest and principal) =} no residual cash flow rights (contrary to equity).
no control rights (unless the firm defaults).
As lenders are not owners → no voting power.
