WEEK 14: FINANCIAL MANAGEMENT -2 BUSN 102 – Özge Can

Finding and Allocating Funds 18-2

Financing Alternatives: 1) Debt Financing  Arranging funding by borrowing money 2) Equity Financing  Arranging funding by selling ownership shares in the company, publicly or privately 18-3

Criteria to Compare: Debt vs. Equity  Maturity  Claim on income  Claim on assets  Influence over management  Tax consequences  Employee benefit potential 4

Debt Financing vs. Equity Financing 18-5

Length of Term  Short-Term Financing  Financing used to cover current expenses  Generally repaid within a year  Long-Term Financing  Financing used to cover long-term expenses such as assets  Generally repaid over a period of more than one year 18-6

Cost of Capital  Cost of Capital: Average rate of interest a firm pays on its combination of debt and equtiy  For any financing to make economic sense:  Expected returns > Cost of capital  Cost of capital depends on three main factors: risk, interest rates, opportunity cost 18-7

Interest Rates  Prime Interest Rate  The lowest rate of interest that banks charge for short-term loans to their most creditworthy customers 18-8

Opportunity Cost  Leverage:  The technique of increasing the rate of return on an investment by financing it with borrowed funds  Capital Structure:  A firm’s mix of debt and equity financing 18-9

Financial Leverage: Example Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 18-10

Short-Term Debt Alternatives: 1. Credit Cards  Short term loans by banks to card-holders 2. Trade Credit  Credit obtained by a purchaser directly from a supplier 3. Secured Loans  Loans backed up with assets that the lender can claim in case of default, such as a piece of property 18-11

Short-Term Debt Alternatives: 4. Unsecured Loans  Loans that require a good credit rating but no collateral 5. Line of Credit  An arrangement in which a financial institution makes money available for use at any time after the loan has been approved 18-12

Short-Term Debt Alternatives: 6. Commercial Paper  Short-term promissory notes, or contractual agreements, to repay a borrowed amount by a specified time with a specified interest rate 7. Factoring  Obtaining funding by selling accounts receivable 18-13

Sources of Long-Term Debt: 18-14

Long-Term Debt Alternatives: 1. Long-Term Loans  Bank or other lender provides the fund, borrower agrees to repay within specific term (from 1 to 25 years) 2. Lease  An agreement to use an asset in exchange for regular payment; similar to renting 18-15

Criteria for Long-Term Loans: “Five Cs”CharacterCapacityCapital ConditionsCollateral 18-16

Long-Term Debt Alternatives: 3. Corporate Bonds  A method of funding in which the issuer borrows from an investor and provides a written promise to make regular interest payments and repay the borrowed amount in the future 18-17

Key Types of Corporate Bonds:  Secured Bonds  Bonds backed by specific assets that will be given to bondholders if the borrowed amount is not repaid  Debentures  Corporate bonds backed only by the reputation of the issuer  Convertible Bonds  Corporate bonds that can be exchanged at the owner’s discretion into common stock of the issuing company 18-18

Equity 1. Private Equity  Ownership assets that aren’t publicly traded; includes venture capital and angel investors 2. Public Stock Offerings  Offering shares of stock to the public through a stock market 18-19

Public Stock Offerings (IPOs) Step 1. Preparing the IPO Step 2. Registering the IPO Srep 3. Selling the IPO 18-20

Public Stock Offerings (IPOs)  Underwriter:  A specialized type of bank that buys the shares from the company preparing an IPO and sells them to investors  Prospectus:  An SEC-required document that discloses required information about the company, its finances, and its plans for using the money it hopes to raise 18-21

Next Week – Our Last Session:  Assignment #4: Submission  Summary of Financial markets and investment strategies (Textbook, Chapter 19)  Final Exam – Discussing of quiz#2 and other example questions 22