Financing Decision. Financial Instruments

Transcription

1 Financing Decision Financial Instruments 1

2 Sources of Funding A distinction we have already drawn is spontaneous v. Capital Spontaneous payables accruals expands and contracts, automatically, with the operations of the firm 2

3 Spontaneous use as much as possible free for reasonable levels, financing do not harm relationships with suppliers, workers, gov t, etc. 3

4 Capital The basic dichotomy we will work with is Debt v. Equity But there are other dichotomies that are equally as important Internal v. External Institutional v. Market Some financing will represent combination of debt and equity 4

5 Internal Equity--Retained earnings Typically cheapest form of finance External Institutional Market 5

6 Insitutional Financing (Intermediation) Banks Insurance Companies Pension Funds Mutual Funds Ventrue Capiutalists Government Agencies 6

7 Market Money markets Bond markets high grade junk Equity markets 7

8 Institutional v. Market Institutional small number of suppliers Often 1, usually < 10, rarely > 50 continuing face to face relationship Possible renegotiation mostly debt, though some equity Venture capitalists and VC funds private equity 8

9 Institutional v. Market Market Large number of capital providers annonymous and shifting An institution may administer but not free to renegotiate terms 9

10 How is Financing Done Net Financing 70-85, non-financials US Japan Germany UK Ret L B Sh

11 Pecking Order Firms seem to behave according to the following prefer internal financing if generate cash, pay down LOC s but otherwise keep in marketable securities If external financing needed Debt Convertibles (combination of debt and equity) new shares as last resort 11

12 Debt v. Equity Timing Debt--prespecified payment dates (prin. and interest) and, usually, specified maturity date Equity--so explicit payment schedule, and no maturity date Taxes Debt: interest deductable from corporate income, taxable to payees Equity: dividends not deductable, taxable to payee 12

13 Contingencies Debt Failure to pay--ownership changes and legal procedures Interest rate fluctuations--payments may depend upon current interest rate Stock price fluctuations--may be convertible to common stock and will convert if stock price rises enough 13

14 Contingencies Equity payments not required payment depends upon profitability 14

15 Control Debt Covenants provide for some control over what the firm can do Equity payment of dividend use of proceeds disposal of assets additional debt Voting Rights 15

16 debt terms Timing Paper--< 1 year notes--1 to 10 years Bonds-->10 (usually 20-30) consuls..infinite (issued 1770 s UK) 16

17 debt terms Interest coupon--typically semiannual in US zero coupon--buy bond at discount to face value PIK--payment in kind, other securities 17

18 debt terms Repayment Balloon--due at maturity, often refinanced Amortization--each bond paid some principle each (semi-annual) period Sinking fund--some number of bonds paid off periodically open market repurchase random call serial maturity 18

19 debt terms Fixed v. Variable rate Variable--some index--libor, Prime,etc.--+ Bankrupcy Mortgages v. Debentures Mortgage secured by specific asset Debenture--general obligation of firm Seniority Senior v. Subordinated 19

20 debt terms Callable Firm can buy back bond at prespecified price interest rate drops improvement in firm s fortions Typically is call protection period 20

21 debt terms Convertible bond can be turned back to firm in return for stock at prespecified terms (number of shares per bond) convertible bond is typically callable so that firm can force conversion 21

22 Convertible Example Face value of bond = 1000 exercise price = 25 get 1000/25 = 40 shares for each bond turned in to company Suppose stock price is 30, and call price is 1100 if bond called and turned in get 1100 if bond converted get 30*40 =

23 Preferred Stock Combination of pure debt and equity No maturity date Dividends payable if and when declared no voting rights (unless triggered by nonpayment of dividends) cumulative (almost always) all past and current pfd dividends must be paid before common stock gets a dividend 23

24 Preferred dividends not tax deductable from corp earnings Often callable and/or convertible Stand in line before (have preference over) common stock holders 24

25 Common Stock No maturity date residual claimant in event of financial difficulty Control voting right represented by Board of Directors (?) stockholders, in aggregate, can control BOD, mergers, recapitalizations 25

26 Warrants Gives right (not obligation) to buy a share of stock at a prespecified price on or before the maturity date Typically fairly long term (5-10 years) no control rights 26

27 Warrant Example Exercise price--20 current stock price--15 maturity 10 years If stock price is 30 in ten years, payoff on warrant is = 10 If stock price is 18 in ten years, warrant payoff is zero. 27

28 Financing Decision Firm considers flexibility of equity v. legal obligations of debt tax deductability of debt v. no tax deductability of equity loss of control with debt (covenants) v. freedom of equity What should the firm do to create the most shareholder value? 28