FINANCING DECISIONS How to Finance Assets Debt Instruments Mortgage Bonds- secured with real estate Chattel Bonds- secured with personal property Unsecured Debt Debentures- Backed by name only “Junk Bonds”- Very high risk, high yield Payment made on debt is interest

FINANCING DECISIONS Equity Securities- Shares of ownership in company Common Stock Voting rights Price Volatile Last to receive Value Created- dividends Preferred Stock Preference over common for dividends no voting rights higher yield than common

FINANCING DECISION RULE FINANCING SHOULD RESULT IN MAXIMUM SHAREHOLDER VALUE To maximize value- maximize stock price To maximize Stock price- maximize EPS EPS = Net Income/ No. shares common stock outstanding

MAXIMIZING FIRM VALUE Example- 1. Assume EPS = $3.00/Share 2. If Valuation multiple is 25, then Market Price is $75/Share 3. Multiply Shares Outstanding by Market Price (EG) 20,000,000 shares X $75/share = $1,500,000,000 4. If EPS rises to $4.00/share, then market value increases to 20,000,000 shares X $100/ share = $2,000,000,000 5. Share price is 25 x $4.00/share = $100/share

EBIT-EPS ANALYSIS EBIT operating earnings LESS: INTEREST debt x int. rate NIBT pre-tax earnings LESS: TAX NIBT x tax rate NIAT NIBT-TAX LESS: P/S DIV. Niat x Payout rate EARNINGS AVAIL. NIAT-P/S Div No. shares C/S O/S Earnings available/ CS OS = EPS Earnings per Share

EBIT-EPS ANALYSIS EBIT $10000 Operating Earnings Less: Interest -1000 $20000x.05 NIBT 9000 EBIT-Interest Less: Tax - 4500 NIBTx .50 NIAT 4500 NIBT-TAX Less: P/S DIV -1500 NIAT-(PSxRATE) Earnings Available 3000 NIAT-P/S DIV =EPS $.30 NO. Shares C/S O/S 3000/ 10000

EBIT-EPS EXAMPLE Current Structure EBIT $150000 LESS: INT ($250000X.10) -25000 NIBT 125000 LESS: TAX (.50) -62500 NIAT 62500 LESS: P/S DIV. -12500 EARNINGS AVAIL 50000 . No. shares C/S O/S 50000 =EPS $1/Share

FINANCING NEW PROJECT 1. Project cost is $400000 2. Additional EBIT will be $200000 3. Tax rate is .50 4. Can finance with all debt at .06 or, 5. Issue 50000 new shares at $8/Share 6. Existing Capital Structure remains in place 7. Calculate EPS under each alternative 8. NO. SHARES O/S IS 50000 9. Pick Financing method with higher EPS

FINANCING NEW PROJECT CURRENT DEBT COMMON EBIT $150000 $300000 $300000 -INT -25000 - 49000 - 25000 NIBT 125000 210000 275000 -TAX (.50) -62500 -105000 -137500 NIAT 62500 105000 137500 -P/S DIV -12500 -12500 -12500 EARN. AV 50000 92500 125000 / C/S O/S 50000 50000 100000 EPS $1/SH $1.85/SH $1.25/SH