long-term financing. basics of long-term financing
TRANSCRIPT
11Long-Term Financing
11.1Basics of Long-Term Financing
Types of Long-Term FinancingCommon stockLong-term debtPreferred stockLeasingOption-type security
WarrantConvertible
Factors Influencing Long-Term Financing Decisions
Target capital structureMaturity matchingInterest rateThe firm’s current and forecasted conditionsOther factors
11.2Common Stock
Common StockCommon stock means different things to
different people, but it is usually applied to stock that has no special preference either in receiving dividends or in bankruptcy.
The common stockholders are the owners of a corporation.
Legal Rights and Privileges of Common stockControl of the firm
The stockholders have the right to elect the firm’s directors, who in turn elect the officers who manage the business.
The problem of control has become a central issue in finance in recent years.
The Preemptive RightA provision in the corporate charter or bylaws that
gives common stockholders the right to purchase on a pro rat basis new issues of common stock or convertible securities.
Other rights and privileges
Major Advantages of Common Stock FinancingThere is no obligation to make fixed
payments.Common stock never matures.The use of common stock increases the
creditworthiness of the firm.Stock often can be sold on better terms than
debt.
Major Disadvantages of Common Stock FinancingThe costs of stock financing are high.Using stock can raise the firm’s cost of
capital.Dividends paid on common stock are not tax
deductible.It extends voting privileges to new
stockholders.New stockholders share in the firm’s profits.
The Market for Common StockOrganized security exchange marketOver-the-counter market
Types of stock market transactionTrading in the outstanding shares of
established, publicly owned companies: the secondary market
Additional shares sold by established, publicly owned companies: the primary market
New public offerings by privately held firm: the primary market.
The Investment Banking ProcessRaising capital: Stage I decisions
Amount to be raisedTypes of securities used.Competitive bid vs. negotiated deal.Selection of an investment banker.
Raising capital: Stage II decisionsReevaluating the initial decisionsUnderwritten issuesIssuance costsSetting the offering price
Selling procedures
11.3Long-Term Debt
Debt InstrumentsTerm loans – a long-term debt contract under
which a borrower agrees to make a series of interest and principal payments on specific dates to the lender.
Bond – a long-term under which a borrower agrees to make a series of interest and principal payments on specific dates to the holder of the bond.
Bond RatingBond ratings are based on both qualitative and
quantitative factors, including the financial strength of the company as measured by various ratios, collateral provisions, seniority of the debt, restrictive covenants, provisions such as a sinking fund, litigation possibilities, regulation and so on.
Bond ratings are important both to firms and to investors.Indicate its default risk and influence the bond’s interest
rate and the firm’s cost of debt.Institutional investors are restricted to investment-grade
securities.Changes in a firm’s bond rating affect both its ability to
borrow long-term capital and the cost of that capital.
11.4Hybrid Financing
Preferred StockA hybrid security having characteristics of debt
and equity.Similar to debt: it has a claim on the firm’s earnings
ahead of the claim of the common stockholders.Similar to equity: debtholders have a prior claim on
the firm’s income and assets.Major provisions
Priority to assets and earningsPar valueDividendsConvertibility
Pros and Cons of Preferred StockPros
Preferred dividends are limitedFailure to pay preferred dividends will not
bankrupt the firmCons
The cost of preferred stock is higher than that of a debt because preferred dividends payments are not tax deductible.
Leasing A means of obtaining the use of an asset without
purchasing the asset.Leasing is similar to a loan and is used by financial
managers as an alternative to borrowing to purchase fixed assets.
Types of leaseSale and leaseback - an operation whereby a firm sells land,
buildings or equipment and simultaneously leases the property back for a specified period under specific terms
Operating lease – a lease under which the lessor maintains and finances the property.
Financial lease – a lease that does not provide for maintenance services, is not cancellable and is fully amortized over its life.
OptionA contract that gives the option holder the
right to buy or sell an asset at some predetermined price within a specified period of time.
Option features are used by firms to “sweeten” debt offerings.
Option-type securities, particularly warrants and convertibles, are attractive to investors because they allow debtholders to acquire common stock at bargain prices and thus to share in the capital gains if a company is especially successful.
WarrantA long-term option to buy a stated number of
shares of common stock at a specified price.A warrant will be exercised if it is about to
expire and the stock price is above the exercise price.
Convertible A security, usually a bond or preferred stock,
that is exchangeable at the option of the holder for the common stock of the issuing firm.
Conversion ratio (CR) is the number of shares of common stock that can be obtained by converting a convertible bond or a share of convertible preferred stock.
Conversion price = Par value of bond / CR