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, If EPS rises to $4.00/share, then market value increases to 20,000,000 shares X $100/ share = $2,000,000, 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. P/s X 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 $20000x.05 NIBT 9000 EBIT-Interest Less: Tax NIBT x.50 NIAT 4500 NIBT-TAX Less: P/S DIV NIAT-(PS x RATE) Earnings Available 3000 NIAT-P/S DIV =EPS $.30 NO. Shares C/S O/S 3000/ 10000

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

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

FINANCING NEW PROJECT CURRENT DEBT COMMON EBIT $ $ $ INT NIBT TAX (.50) NIAT P/S DIV EARN. AV / C/S O/S EPS $1/SH $2.76/SH $1.50/SH