Materials Conveyed for the Seminar on Financial Management Class By: Prof. Dr. Eric Y Nasution LONG-TERM FINANCING: TYPES, IMPACT ON FINANCIAL LEVERAGE, AND COST OF

1. LONG-TERM LOAN (fr the banking system) 2. BOND PAYABLE (fr the capital market system) 3. LEASE PAYABLE (fr the financing company) 4. PENSION FUNDS (fr the employees’ payroll) 5. EQUITY FINANCING (fr the capital market system) a. Initial public offering (IPO)  Preferred + common b. Right offering

ASSETSLIABILITIES & EQUITY Current assets xxx Fixed assets (net) xxx Investment (securities) xxx Intangible assets xxx INVESTMENT FUNCTION Current liabilities xxx Long-term debt: Investment loan xxx Bonds payable xxx Lease payable xxx Pension funds xxx Total long-term debt xxx Stockholders’ equity: *Preferred stock xxx *Capital stock xxx *Retained earnings xxx FINANCING FUNCTION

INCOME STATEMENTLeverage interpretation Sales xxx Cost of goods sold xxx Gross profit xxx Selling, general & administrative xxx Operating profit (ebit) xxx Interest expenses xxx Other expenses /(income) xxx Total financing & other cost xxx Profit before tax xxx Income tax xxx Net profit xxx EPS (us $) $$$ Dividend (% Pay Out) $$$ OPERATIONAL FUNCTION OP OP  OPERATING LEVERAGE OP FIN FIN  FINANCIAL LEVERAGE FIN

OPERATING LEVERAGEFINANCIAL LEVERAGE Break-even point  Sales Control  Fixed cost DOL  % ebit chg./% sales chg. Formula  Fixed cost/% margin contribution (income) Decision  (1) Strategic volume and selling price (2) Reducing selling price Break-even point  EPS for a certain level of ebit Control  Interest cost DFL  % EPS chg./% ebit chg. Formula  (ebit-interest)(1-tax) for debt and equity alternatives *Decision  (1) Debt: If break-even ebit ebit normal

LONG-TERM DEBTS: Bond payable $ 20 m Stockholders’ equity 80 m * Capitalization $ 100 m * Outstanding shares = 40 m THE FIRM AIMS TO RAISE $ 15 m: 1 st Alt: Addtl bond at 10% p.a. 2 nd Alt: Addtl shares at $ 1.5/share Income tax is assumed at 40%. COSTING OF BOTH ALTERNATIVES: Bond  10% interest or $ 1.5 m Equity  $ 15 m : $ 1.5 or addtl shares of 10 m. FORMULA APPLIED: (ebit – interest) (1 – t) = (ebit – interest) (1 – t) outstanding shares outstanding shares and we will derive the ebit at break-even EPS

(ebit – interest expense) x (1 – income tax) : o/s shares EQUAL TO (ebit - interest expense) x (1 – income tax) : o/s shares (ebit – $ 1.5 m) x (1 – 40%) : 40 million shares = (ebit – 0) x (1 – 40%) : (40 million + 10 million) 30 ebit – 45 = 24 ebit  6 ebit = 45 ebit = $ 7.5 million

DEBT ALTERNATIVE:k = 10% p.a.EQUITY ALTERNATIVE: Price $ 1.5/sh ebit 7.5 Less Interest expense ( 1,5 ) Profit before tax 6.0 Less income tax (40%) 2.4 Net profit 3.6 O/s shares (million) 40 EPS – In US$ 0.09 ebit 7.5 Less Interest expense ( 0 ) Profit before tax 7.5 Less income tax (40%) 3.0 Net profit 4.5 O/s shares existing (million) 40 additional (million) 10 Total o/s shares 50 EPS – In US$ 0.09

Description NORMAL SCENARIO B/E EBIT SCENARIO Sales Cost of sales Gross profit SGA expenses Operating profit (ebit) $ 60.0 m 32.0 m 28.0 m 10.0 m 18.0 m Normal ebit $ 40.0 m 24.0 m 16.0 m 8.5 m 7.5 m Ebit at break-even EPS

DEBT STRATEGYEQUITY STRATEGY Break-even EBIT < EBIT normal Break-even EBIT > EBIT normal

DescriptionEXISTING STRUCTURE NEW STRUCTURE CAPITALIZATION: Bonds payable Stockholders’ equity Total capitalization $ 20 m 80 m $ 100 m $ 35 m 80 m $ 115 m

DEBT(Kd)PREFERRED STOCK (Kp) EQUITY (Ke) Weight  % Cost of debt (Kd): LT Credit  Eff. interest Bond  ytm Lease  Amortization Weighted average cost: LT Credit  % x eff int Bond  % x ytm Lease  % x amortization Weight  % Cost of pref. stock (Kp): Dividend ratio  Yield Weighted average cost: % x yield Weight  % Cost of equity (Ke): Dividend yield + g (growth) Weighted average cost: % x (dividend yield + g)

ICI 3-year Bond Issue, interest = 8% p.a. and fee = 6%. Description Cfo CF 1-2 CF3 SumPV NPV Funds inflow 94 Yearly interest cost payment ( 8) ( 8) Principal repayment (call price) ( 105) 94 ( 8) ( 113) Factor = 11% * Factor = 12% – * Computed: $ 96,307 m - $ 94 m or $ m Interpolation: Ytm = 11% + (12% - 11%) x : {2.307 – ( )}  11% % atau 11.99% (using HP 12c calculator or Casio calculator: 94 CHS g CF0, 8 g PMT, 2 g Nj, 113 g PMT  f IRR = 11.98%, difference due to decimal point)

SUSTAINABLE GROWTHCAPITAL ASSET PRICING MODEL Objective: Growth is directed to the reinvestment of net income to sustain operation of the firm. Formula: Ke = D/P + g, where D=dividend per share at CFo P=Price per share g= Growth rate, which is the reinvested ROE (1 – pay out) ROE=return on equity (%) pay out=% dividend payment (from the net income) Objective: Growth is directed to the minimum income offered by the investment in fixed-income securities callled Treasury bill + risk premium. Formula: Ke = Rf+beta(Rm – Rf), where Rf = Rate of return offered by the Treasury bill with less risk level beta= Risk level Rm=ROE of the industry

Ke = (EPS x 50% div pay out) : (EPS x P/E) (1 – fee) + ROE (1 – div pay out) Ke = ($ x 50% pay out) : ($ x 12)(1-3%) % (1 – 50%) So the Ke = $ : $ %  6.617% Description Projected net profit Dividend payment (pay out 50%) Retained earnings (RE) RE ending balance(2007=$ m) Equity (ending bal 2007=$ 30.0 m)* Return on equity or ROE (%) ** *Average equity = $ per year ** Average ROE = 4.635% per year

=======Rf = 5%=======Rm=6,3%======= Beta=2======= ILLUSTRATIVE CASE, Inc. (ICI) Least square computation for Beta YearRjRmJumlahJumlah Rj xJumlah(Jumlah Rm) Rj x Rmjumlah RmRm 2 pangkat ,25,411,8829, ,25,824,3633, ,56,234,1038, ,67,859,2860,84 Jumlah19,525,2129,62491,40162,08635,04

SUSTAINABLE GROWTH Financing Amount Weight Cost w a c c Computation Bond payable $ 5.0 m 9.1% 12.06%  9.1% x 12.06% Equity % 6.617%  90.9% x 6.617% Total capital 54.7 m Ko (sustainable growth) = 7,112% CAPITAL ASSET PRICING MODEL Financing Amount Weight Cost w a c c Computation Bond payable $ 5.0 m 9.1% 12.06%  9.1% x 12.06% Equity % 7.600%  90.9% x 7.600% Total capital 54.7 m Ko (capital asset pricing model) = 8.005%

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