Chapter 14 Principles of Corporate Finance Tenth Edition

Chapter 14 Principles of Corporate Finance Tenth Edition An Overview of Corporate Financing Slides by Matthew Will Mc. Graw-Hill/Irwin Copyright © 2011 by the Mc. Graw-Hill Companies, Inc. All rights reserved.

Topics Covered Ø Patterns of Corporate Financing Ø Common Stock Ø Debt Ø Financial Markets and Institutions 14 -2

Patterns of Corporate Financing Ø Firms may raise funds from external sources or plow back profits rather than distribute them to shareholders. Ø Should a firm elect external financing, they may choose between debt or equity sources. 14 -3

Patterns of Corporate Financing Internal funds 100% Chart Title Net equity issues Net borrowing 50% 0% -50% 08 20 07 20 06 20 05 20 04 20 03 20 02 20 01 20 00 20 99 19 98 19 97 19 96 19 95 19 19 94 -100% 14 -4

Patterns of Corporate Financing 14 -5

Patterns of Corporate Financing How do we define debt ? 14 -6

Debt Ratios Debt Ratio, % Debt to Net Worth for Non-Financial Firms, 1950 -2008 14 -7

Patterns of Corporate Financing 14 -8

Common Stock Book Value vs. Market Value Book value is a backward looking measure. It tells us how much capital the firm has raised from shareholders in the past. It does not measure the value that shareholders place on those shares today. The market value of the firm is forward looking, it depends on the future dividends that shareholders expect to receive. 14 -9

Common Stock 14 -10 Example – Honeywell Book Value vs. Market Value (Dec. ‘ 08) Total Shares outstanding = 735 million

Common Stock 14 -11 Example – Honeywell Book Value vs. Market Value (Dec. ‘ 08) Total Shares outstanding = 735 million

Holdings of Corp Equities (2008) Percent of Holdings 14 -12

Preferred Stock 14 -13 Preferred Stock - Stock that takes priority over common stock in regards to dividends. Net Worth - Book value of common shareholder’s equity plus preferred stock. Floating-Rate Preferred - Preferred stock paying dividends that vary with short term interest rates.

Issues with Common Stock Ø Who owns the corporation? Ø Voting procedures Ø Dual class shares and private benefits Ø Partnerships Ø Trusts Ø REITs 14 -14

Corporate Debt Ø Debt has the unique feature of allowing the borrowers to walk away from their obligation to pay, in exchange for the assets of the company. Ø “Default Risk” is the term used to describe the likelihood that a firm will walk away from its obligation, either voluntarily or involuntarily. Ø “Bond Ratings”are issued on debt instruments to help investors assess the default risk of a firm. 14 -15

Corporate Debt 14 -16

Corporate Debt Prime Rate - Benchmark interest rate charged by banks. Funded Debt - Debt with more than 1 year remaining to maturity. Sinking Fund - Fund established to retire debt before maturity. Callable Bond - Bond that may be repurchased by firm before maturity at specified call price. 14 -17

Corporate Debt Subordinate Debt - Debt that may be repaid in bankruptcy only after senior debt is repaid. Secured Debt - Debt that has first claim on specified collateral in the event of default. Investment Grade - Bonds rated Baa or above by Moody’s or BBB or above by S&P. Junk Bond - Bond with a rating below Baa or BBB. 14 -18

Corporate Debt Eurodollars - Dollars held on deposit in a bank outside the United States. Eurobond - Bond that is marketed internationally. Private Placement - Sale of securities to a limited number of investors without a public offering. Protective Covenants - Restriction on a firm to protect bondholders. Lease - Long-term rental agreement. 14 -19

Corporate Debt Warrant - Right to buy shares from a company at a stipulated price before a set date. Convertible Bond - Bond that the holder may exchange for a specified amount of another security. Convertibles are a combined security, consisting of both a bond a call option. 14 -20

Holdings of Corp Debt (2008) Percent of Holdings 14 -21

Financial Manager Questions 1. Should the company borrow short term or long term? 2. Should the debt be fixed or floating? 3. Should you borrow dollars or some other currency? 4. What promises should you make to the lender? 5. Should you issue straight or convertible bonds? 14 -22

14 -23 Financial Markets Money Primary OTC Markets Secondary Markets

Financial Institutions Company Obligations Funds Intermediaries Banks Insurance Cos. Brokerage Firms 14 -24

Financial Institutions Intermediaries Obligations Funds Investors Depositors Policyholders Investors 14 -25

Web Resources Click to access web sites Internet connection required www. census. gov/csd/qfr www. federalreserve. gov/releases 14 -26