McGraw-Hill/Irwin

Copyright 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Introduction to Corporate Financing

Firms have three sources of cash from which to finance their activities. This chapter provides an overview of debt, equity, and internally generated funds.

14-2

Financial Markets
Competition in financial markets is fierce-much more so than in product markets. Few protected niches (ex: cannot patent the structure of a new security)
Securities sell for their true values

14-3

Corporate Financing
Firms have three broad sources of cash. Internally generated funds New equity issues New debt issues
14-4

Internally Generated Funds

Historical sources of funds for FedEx 1995-2010

14-5

Why Internal Funds?

Managers prefer to reinvest internal funds for a number of reasons:
Cost of issuing securities

New equity announcement implications

14-6

Corporate Financing
What happens when the firm cannot finance all of its activities from plowed-back funds? Financial Deficit New Equity Issues New Debt Issues
14-7

Equity Issues
Most corporations are too large to be owned by one investor; therefore they issue stock to many investors.

Example:
Dow is owned by 650,000 different investors. If it has 1.167 billion shares outstanding, how much of Dow does an investor who holds one share own?

The investor owns:

, or 0.000000085% of Dow
14-8

Equity Terminology
Treasury stock
Stock that has been repurchased by the company and held in its treasury.

Issued shares and Outstanding Shares

Shares that have been issued by the company; shares that have been issued by the company and are held by investors.

Authorized Share Capital

The maximum number of shares that the company is permitted to issue without additional shareholder approval.
14-9

Equity Terminology: Example

Imagine a firm has 100 million shares currently trading on the NYSE. The firm issues 20 million new shares, and repurchases 5 million shares one month later.
What is the total change in treasury stock? What is the total change in the number of issued shares? What is the total change the number of shares outstanding?

14-10

Equity Terminology
When a firm issues new equity, it records each new share in its books at par value. Additional Paid-in Capital
The difference between the issue price and the par value of a stock

Retained Earnings
Earnings not paid out as dividends

14-11

Equity Terminology: Example

Suppose a firm has recently issued 10 million new shares at $15 per share; the par value of each is $1.50.

What is the value of additional paid-in capital (APIC)?

14-12

Net Common Equity

Represents the total amount contributed directly by shareholders when the firm issued new stock, and contributed indirectly when it plowed back part of its earnings Net Common Par Additional Retained = Value + Paid-in Capital + Earnings Equity

Share Repurchases

14-13

Net Common Equity: Example

What is the book value per share of equity for a firm with $1 million in net common equity; $50,000 in authorized share capital; 25,000 shares issued; and 20,000 shares outstanding?

14-14

Corporate Ownership
A corporation is owned by its common stockholders.
Owners are entitled to:

Profits

Control of the firm

14-15

Corporate Ownership
Shareholders exercise control over the firm by voting for its board of directors.

Majority Voting
Voting system in which each director is voted on separately

Cumulative Voting
Voting system in which all votes that one shareholder is allowed to cast can be cast for one candidate for the board of directors

Proxy Contest
Takeover attempt in which outsiders compete with management for shareholders votes
14-16

Corporate Ownership: Example

A shareholder owning 100 shares of stock is voting for the board of directors who are elected by cumulative voting. How many votes did the shareholder cast for Director 'A' if four directors are to be elected and the shareholder cast his/her maximum number of votes for 'A'?

400

14-17

Preferred Stock

Preferred Stock Advantages: Dividends Tax Advantages Potential Disadvantages: Interest rate fluctuations Floating Rate Preferred
14-18

Corporate Debt
When issuing debt, companies promise to make payments and repay principal. But they have limited liability; debt is not always repaid.

14-19

Debt Characteristics
Interest rate fluctuations
Coupon vs. Zero-coupon Bonds Prime Rate LIBOR

Would you expect the price of a 10-year floating-rate bond to be more or less sensitive to changes in interest rates than the price of a 10-year fixed-rate bond?

14-20

Debt Characteristics
Funded and Unfunded Debt
Debt with more than 1 year remaining to maturity; debt due in less than one year.

Sinking Fund
A fund established to retire debt before maturity.

Callable Bond
A bond that may be repurchased by a firm before maturity at a specified call price.

If interest rates rise, would holders of callable bonds expect the firm to buy back the debt?
14-21

Debt Characteristics
Seniority Subordinated Debt Security Secured Debt Currency and Country of Origin Eurodollars Eurobond
14-22

Debt Characteristics
Public vs. Private Placements
Protective Covenants
Restrictions on a firm to protect bondholders

Leases
Long-term rental agreements

14-23

Convertible Securities
Give investors the option to alter their investments if they so choose.

Warrant
The right to buy shares from a company at a stipulated price before a set date

Convertible Bond
A bond that the holder may exchange for a specified amount of another security

14-24

Convertible Securities: Example

An investor owns a bond selling for $1,000. This bond can
be converted to 20 shares of stock that are currently selling for $55 per share. Should the investor convert his bond into shares?
Without conversion:

With conversion:

14-25