1. Robert Uberman, Financial Management, KA im Frycza Modrzewskiego 12

2. Session Twelve Topics Business financing overview Business financing overview Debt financing – financial markets Debt financing – financial markets Debt financing – banks Debt financing – banks Equity Equity Other sources of financing Other sources of financing

3. Robert Uberman, Financial Management, KA im Frycza Modrzewskiego Balance Sheet basic analysis Sources of finance Structuring criteria: Structuring criteria: duration duration form of remuneration form of remuneration providing entity providing entity legal form legal form Long term vs short term Long term vs short term

4. Robert Uberman, Financial Management, KA im Frycza Modrzewskiego Balance Sheet basic analysis Sources of finance Remuneration: Remuneration: (Accounts) payables ---> cost included in price/cost of the original item (Accounts) payables ---> cost included in price/cost of the original item Loans (and overdrafts, receivables discounting), debentures (bonds), leases Loans (and overdrafts, receivables discounting), debentures (bonds), leases --- > interests Equity ----> profit (dividends + growth) Equity ----> profit (dividends + growth)

5. Robert Uberman, Financial Management, KA im Frycza Modrzewskiego Balance Sheet basic analysis Sources of finance Providing entity: Providing entity: Shareholders Shareholders stock stock preferred stock preferred stock subordinated loans subordinated loans Investors special category: Bonds Investors special category: Bonds Financial institutions (mainly banks) Financial institutions (mainly banks) loans loans overdraft overdraft trade receivables discounting trade receivables discounting financial institution may also act as investors financial institution may also act as investors

6. Robert Uberman, Financial Management, KA im Frycza Modrzewskiego Sources of Finance – pricing Each financing instrument represents an investment for a capital providing entity. Each financing instrument represents an investment for a capital providing entity. Each equity and liability instrument may have a market value dependent on: Each equity and liability instrument may have a market value dependent on: expected return, expected return, associated risk, associated risk, liquidity of a given instrument. liquidity of a given instrument. Market value of liabilities are much easier to calculate than those of equity. Market value of liabilities are much easier to calculate than those of equity. A rule of thumb says that liabilities cannot be purchase on a market by a liable entity. A rule of thumb says that liabilities cannot be purchase on a market by a liable entity.

7. Robert Uberman, Financial Management, KA im Frycza Modrzewskiego Financial markets Bonds, especially quoted on regulated financial markets: Bonds, especially quoted on regulated financial markets: Accessible for renowned companies or investors Accessible for renowned companies or investors Issued with different maturities (short-term are named notes) Issued with different maturities (short-term are named notes) Usually very liquid Usually very liquid Common in US and UK but gaining importance elsewhere Common in US and UK but gaining importance elsewhere Other forms: Other forms: Private placement Private placement Preferred stock Preferred stock Financial markets usually do not seek high interests but insist on security (exception: junk bonds) Financial markets usually do not seek high interests but insist on security (exception: junk bonds) Brealey, Myers pp. 640-62 Brealey, Myers pp. 640-62

8. Robert Uberman, Financial Management, KA im Frycza Modrzewskiego Maturity & Yield to Maturity Maturity is a period for which a loan (or other form of financing is granted) Maturity is a period for which a loan (or other form of financing is granted) Yield to maturity is nothing else but a rate of interest paid (price, cost) for obtaining a financing Yield to maturity is nothing else but a rate of interest paid (price, cost) for obtaining a financing Z – bond: a zero coupon bond = does not pay interest

9. Robert Uberman, Financial Management, KA im Frycza Modrzewskiego Yield to Maturity with interest paying bonds When an interest (coupon) is to be paid the yield has to be calculated as both coupons and a principal are actually equal to zero-coupon bonds – different payments When an interest (coupon) is to be paid the yield has to be calculated as both coupons and a principal are actually equal to zero-coupon bonds – different payments * -The second method is valid on the following two conditions: (1) purchasing price = principal (2) all coupons are equal

10. Robert Uberman, Financial Management, KA im Frycza Modrzewskiego Banks Asset based financing: Asset based financing: Leasing (based on fixed assets) Leasing (based on fixed assets) Factoring (based on receivables) Factoring (based on receivables) Other forms: Other forms: Credit notes Credit notes Loans Loans Banks usually do not seek high interests but try to reinforce sales of other services Banks usually do not seek high interests but try to reinforce sales of other services Brealey, Myers pp. 640-62 Brealey, Myers pp. 640-62

11. Robert Uberman, Financial Management, KA im Frycza Modrzewskiego Equity Financing provided by owners (although owners may also use debt financing but always additionally): Financing provided by owners (although owners may also use debt financing but always additionally): Residual value of all assets remaining after satisfying all liabilities (including debt paid back to owners) Residual value of all assets remaining after satisfying all liabilities (including debt paid back to owners) The most risky and volatile form of financing The most risky and volatile form of financing Essential for business existence Essential for business existence

12. Robert Uberman, Financial Management, KA im Frycza Modrzewskiego Equity vs Debt Financing (1) Miller-Modigliani Preposition I: Miller-Modigliani Preposition I: A firm cannot change it’s value through changing a financial structure thus investment decision have to be taken disregarding financing methods A firm cannot change it’s value through changing a financial structure thus investment decision have to be taken disregarding financing methods There are no taxes & financial markets are perfect There are no taxes & financial markets are perfect Miller-Modigliani Preposition II: Miller-Modigliani Preposition II: Expected yield on shares rises as share of debt-financing increase Expected yield on shares rises as share of debt-financing increase Tax credit favours debt Tax credit favours debt Increasing debt drives risk up Increasing debt drives risk up Brealey, Myers pp. 450-457 Brealey, Myers pp. 450-457

13. Robert Uberman, Financial Management, KA im Frycza Modrzewskiego Equity vs Debt Financing (2)

14. Robert Uberman, Financial Management, KA im Frycza Modrzewskiego Homework Calculate: a) a) yield to maturity on 7 percent, 8-year bond selling at 74,5; b) b) price of 7 percent, 9-year bond yielding 10 percent; c) c) price of 8 percent, 12-year bond yielding 14 percent; (Brealey, Myers, Chapter 23, Q 4, use either Table 23-1 or a spreadsheet)