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UR / Finance / FIN 204 / What are the patterns of corporate financing?

What are the patterns of corporate financing?

What are the patterns of corporate financing?

Description

School: University of Rochester
Department: Finance
Course: Principles of Finance
Professor: Derek mohr
Term: Spring 2019
Tags:
Cost: 50
Name: FIN 204 Midterm 1 Study Guide
Description: These note cover what's going to be on our first exam
Uploaded: 03/02/2019
3 Pages 47 Views 5 Unlocks
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What are the patterns of corporate financing?



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CHAPTER 14: AN OVERVIEW OF CORPORATE FINANCING Patterns of Corporate Financing

• Firms may naise funds from external sources/plow back profits rather than distribute them to shareholders

o should a firm eleet external financing, they may choose between debt or equity sources


What is the meaning of authorized share capital?



• Net equity issues negative means that the cash raused by share issues was less than the cash paid out to share holders by repurchase of previously outstanding shares corporations can buy back their own shares, purchase and retire other firms')


What is the meaning of voting procedures?



Don't forget about the age old question of Who are the members of the house of representatives?
Don't forget about the age old question of What is the definition of dividends?

$1,802

Total long termilities

Current assets

$2,454 Current liabilities Fixed assets 3,821

Long term debt 2,014 Less

1,791

long term debt 1,324 Depreciation

Liabilities

3, 338 Net fixed asset If you want to learn more check out How do we measure ecological community?

1,530

3,338 Other longterm

5,129 Stockholclers' equity Total assets We also discuss several other topics like What is the independent variable (iv)?
If you want to learn more check out What is a video discovery ad?
We also discuss several other topics like What are intrinsic neurons?

9,113 Total licebilities

and stockholders

equity Aggregate balance sheet for manufacturing Corporation in

the United states, 2014 (figures in billions)

3,973

9, 43

Stude

SOU

SEU

Common Stock * Authorized share capital - maximum no of shares that can be lisued ex Honeywell 's is a billion shares. If management wishes to a then

of authonized shares, it needs the agreement of shareholders.

e Issued and outstanding shares: held by investors

• Treasury shares, issued but NOT Outstanding o Par value: nominal value of a bond, share of stock as indicated to writing on the document (same as face value)

sen fram

ex: Honeywell sold 100,000 shares at $40 a share the common Stock account would increase by 100.000 x $1.00 - $100.000 (Each Honeywell share had å par value of $1.00) the capital surplus alccount ^ by 100000 x$39 $3,900.000

Holdings of corporate Equities (2014)

other 1.4%)

Team T Vimin terston Hotels 14.

B62%/2a01

W

Mutual funds, etc (25.1%)

world Insurance companies

- 6.1%)

(16.1% Voting Procedures

_ a system of majonty voting: each director is voted separately and Stockhoden can cast ivote for each share they own'

- Cumulafive voting the clirectors are voted upon jointly and stockholders can allot all their votes to just' one candidate. - Supermajority - needed to approve a merger Pual-Class Shares and private benefits

-Two classes of stock:

B same cash flow rights, different conid nights 27 Creater control sights grant private benefits

equity in Disquise

1

(

o Partnerships

- Avoid corporate income tax, limited life span lex: Plains All American Pipelinell - Master limited partnership that owns crude oil pipelines in us and CAN. + They share in profits and receive cash distributions

Studs

• Tusts : passive owner of a single asset e Real Estate Investment Trust" (REID) :

- not taxed - restricted to real estate

Preferred stock

- provides only a small part of most companies' cash needs - useful method of financing in mergers

fakes prionty over common stock when receiving diudends - gains some voting rights if corporation fails to pay preferred dividends

Debt - has unique feature of allowing the borrowers to walk away from their obligation to pay, in exchange for the assets of the company

-'" Default nisk'- used to describe the likelihood that a firm Will walk away from its obligation (voluntarily/involuntanly) | "Bond rabings" - issued on debt instruments to help investors assess the default risk of a firm

Debt by Any other Name Some debts treated differently in accounts

- Accounts payable

o Good received, not yet paid for

Very short-term debt - Unfundied obligations : senior debt (employee pensions)

Debt (cont.)

-Special-purpose entities (SPES)

raise Lash through equity & debt do not show up on balance sheet

The Role of financial Markets and Intermedianes

• Payment Mechanism

- Allows individuals to make and receive payments quickly and safely over long distances

· Borrowing and Lending - Channels savings towards who can bestuse them

• Pooling Risk

- Allows individuals to share nisk (insurance companies)

• Information

-Allows estimation of expected rates of return

Debt Ratio Debt

Total assets

Long term liabilities Long term Liabilities + Equity

CHAPTER 23: CREDIT RISK AND THE VALLE OF CORPORATE DEBT I. Yields on Corporate Debt

The risk of default changes the price of a bond and the field to Maturity a (YTM) Ex: the interest rate on one-year risk-free bonds is 5%. Backwoods

Chemical Company issues 5% notes with face value of $1000, maturing in one year

PV of notes = $1000 + 50 2 $1000

1.05 o Suppose there is a 20% chance that backwoods will default, holders of its notes receive / of face value of the notes, or $500

- Payoff - Probability No default $1,000 Default $500

2 Expected payment is ,8 x ($1,050) + 2($500) = $940

► disurunt the expected pay off at risk - free int rate - PV of notes = $940 = $995

1.05

An investor who purchased the notes for $895 would receive a YTM - of $1.050 1 = 123 a 17.3%

- $895 II. The option to Default

Ex : Circular Fire borrowed $50 per share, but then the firm fell on hard €

times and the market value of its assets fell to $30. Circular's market - Asset value $30 $25 bonds value balance sheet

T $5 L Stock $20 $30 firm value

If Circular's debt were due and payable now, the firm wouldn't repay $10 it originally borrowed. When Circular borrowed, it acquired an option to default (it's not compelled to repay the debrat matunty).

> Value of its assets < $50 - it chooses to default on the debt and the bond holders will get to keep the assets e bond value = asset value - value of call

Stock value = value of call

• Firm value = asset value valuing corporale bonds

brood value bond value assuming value of but

no chance of default option on assets

1. Bond Ratings and the probability of Default -Bond Ratings are to measure the probability that the borrower will defaud L Principal rating services - Moody's, Standard & Poor's, Fitch - Highest quality bonds are rated triple- A (Aaa) - Investment-grade bonds Baa or higher -bonds rated below bac are fermed "high yield","junk." bonds

TV, Predicting the Probability of Default o Credit Scoring : complete a questionaire providing your details calculate e I an overall credit score assess the risk of their corporate loans (banks) e

t extend credit to customers(firms) 6 Market Based Risk Models:

- build on the idea that stockholders will exercise their ophon to default if market value of the assets fall below the payments that must be

made on the debt

* Credit Analysis - Prediching Default: William Beaver, Maureen Me Nichols, Tung-Wu Rhie Studied defaulting and non-defaulting firms and concluded the chance of failing during the next year relative to the chance of not failing was' best estimated by:

Log (relative chance of feilure) -6.445 -4.192RDA +2.307labilities assets —.846 EBITDA / liabilities

I value at Risk -If the quality of the bonds deteriorate, investors will demand a higher yield and the bond price will fall + Calculating value at niste by looking at the probability of possible ratings changes + estimating the likely effect of these changes for

the bonds price.

. CHAPTER 15: HOW CORPORATIONS ISSUE SECURITIES I Venture Capital

Steps to obtaining venture funding

- Prepare a business plan - Receive first - stage finanung

- Receive subsequent staged financing Venture Capital : money invested to finance a new firm

- Success of new firm dependent on managers - Restrictions placed on management by venture capital company - funds usually dispersed in stages after certain level of riccess

1.0

Other assets

1.0

20

First Stage Markot Vakee Balance sheet ($mil) - Assets

| Liabilities and Equity Cash from new equity | 10 New.cquety from venture stage

| 1.0

Your original equity Value

I Value Second Stage

Assets

liablihes e Equity Cash from new equity

4.0 New equity from 2nd stage Fixed assets

1.0 Equity from 1st stage Other assets

9.0 Your oniginal equity Value

$14.

0L Value

40

5.0

414.0

I. The Initial Public Offering

Initial Public Offering (IPO) first offering of stock to the general public . Unclerunter-firm that buys an issue of secunties from a company and resells it to the public e spread - difference between public offer price and price paid by underwriter b. Prospectus- formal summary that prondes information on an issue

of secunities Underpricing - Issuing securities at an offening price set below the true value of the security

* Underwriter Spread

For the issuing company incurs $1 million in expenses to sell 3 mil shares

+ $40 each to an underunter, they sell the shares at $43 each hat's the spread for this deal?

3 million x ($43- $40) - $9 millon

lloc

* Underwriting Arrangements | firm commitment - underwnters buy the securities from the firm and sell them to public

· Best Efforts commitment: Underunters agree to sell as much of the

issue as possible but don't quarantee the sale of the entire issue la Flotation Costs - the costs incurred when afirm issues new secunties

to the public ex: How much will a firm receive in het funding from a firm commitmes commitment underwnting of 250,000 sharespriced to the public at $40 if a H10% underwniting spread has been added to the price paid by the underwnter? The firm pays $600,000 in legal fees

Cost to public

$40 Net to issuers

$40/1.10 = $36.36 Spread was $3.64 per share Net to issuers

= $250,000 x $36.36 $9,090,000 Less: legal fees

600,000 $5,490,000

* Underpricing

incurs $1 mil to sell 3 mil shares af $40.

· underwriter sells the shares at $43 o l'ssuing company's stock price had nisem to $70,

Total cost of underpricing? = 3 million ( $70 - $43) = $81 million

Kudy soup

II. Security Sales by Public Companies

SEX

* General Cash offer – sale of secunihes open to all mvestors by an already publicly traded Shternational Security Issues - sales of secunties in other countries

ex. Eurobond, Global bonds

to Private Placements and Public Issues

• PP : Sale of secunkies to a limited no of investors without a public

offering

• Qualified Institutional Buyer: Entity entitled under SEC Rule 144 A to purchase and trade private placements

CHAPTER 16: PAYOUT POLICY I facts

• Corporationsplan pay a dividend (CASH DIVIDEND))

E I buy back some of outstanding shares (STOCK REPURCHASE) I How firms lay Dividends o Stock Dividend distribution of additional shares to a firm's stockholders . Stock Splits - Issue of additional shares to firm's stockholders o Cash Dividend payment of cash by firm to its shareholders (Regular Special)

Dividend Terms record date, declaration date, payment dates

ex-dividend date (see ex on chap 16, slides)

1. How Firms Repurchase Stock 6 Stock Repurchase : firm truys back stock from its shareholders 6 4 methods

1. Buy shares on the market 2. Tender offer to shareholders 3. Dutch auction 4. Private negotiation (Green Mail)

TV The Payout Decision (see textbook pg 394) J. Stock Repurchases and DCF Models of Share Price

• Calculate Market Capitalization - Done by forecasting and discounting free cash flow paid to shareholders le calculate share pnice = Market capitalization

no of outstanding shares

• Calculate Value of Dividends per share + Account for increased dividend growth rate per share

- caused by declining no of shares as shares are repurchased

Ex: Dividend payout company had 4,000 shares outstanding and that the project had an NPV of $2,000. Value of a company ($10,000 + NPU). The old stock worth in total = $10,000 + NPV = $12,000

Share price = $12.000 $12

1200 1. Dividend Theones - Leftists (M&M) - dividend does not effect value |- Rightists - Dividends increase value

- Middle of the roaders -leftist theory with some reality thrown in Residual Dividend Policy

Dividends Increase Value Market Imperfections x Clientele Effect

• Not any particular firm can benefit by increasing its dividends.

• High dividend clientele already have plenty of high dividend stock

• Increase the price of stock through their demand for a dividend

paying stock

Dividends as Signals

• Dividend increases - good news abt cash flow x larnings Is signals a company's good fostine and its manager's confidence

in future cash flows

Tax Consequences o Convert dividendt = capital gains by shifting dividend policies

• Total sash How retained by the firm, held by shareholders will be higher than if dividends are paid

- Taxes and Radical Left e Capital gains are taxed at lower rate than dividend income companies. should pay the lowest dividend possible

Avidend policy should adjust to changes in taxcode

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