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Fundamentals of Corporate

Finance

Seventh Edition

Richard A. Brealey

Stewart C. Myers

Alan J. Marcus

Slides by

Matthew Will

Chapter 14

McGraw Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved

Introduction to Corporate Financing

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Topics Covered

Creating Value with Financing Decisions Patterns of Corporate Financing Common Stock Preferred Stock Corporate Debt Convertible Securities

Introduction Corporate financing sources Corporate financing patterns The pecking order theory Summary

14- 3 Introduction

Do you think financing create value?

Financing is related to investment project, no investment, no financing. They are reported in a firm’s balance sheet.

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BALANCE SHEETCorporate Investment

Corporate Financing

Assets

Current Assets

Non-current Assets

Fixed assets

Intangible assets

Liabilities

Current Liabilities

Non-current Liabilities

Shareholders’ equity

Common Stock

Preferred Stock

Additional Paid-in Capital

Retained Earnings

Treasury Stock

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Financing Sources

Internal Sources External Sources

Financing Patterns

Plowing Back Profits Issuing Securities

Bank Loan

Lease

Natural Growing Debts

P319 -322 FedEx and Dow chemical

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Common StockAuthorized Share Capital

Maximum number of shares that the company is permitted to issue, as specified in the firm’s

articles of incorporation.

Par Value

Value of security shown on certificate.

Retained Earnings

Earnings not paid out as dividends.

Addiotional Paid Up CapitalDifference between issue price and par

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Common Stock

Voting procedures Majority voting Cumulative voting

Classes of stock Class A Class B

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Common Stock

Example - H.J. Heinz Book Value vs. Market Value (5/2007)

Total Shares outstanding = 322 million p323 table 14.1

1,843Value)(Book equity common Net

219-Other

4,406-costat sharesTreasury

5,779earnings Retained

581capitalin paid Additional

108par) ($.25 SharesCommon

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Common Stock

Corporate Equity Holdings

Mutual Funds28.3%

Pension Funds22.3%

Insurance Companies

8.0%

Rest of World12.6%

Households27.1%

Other1.4%

Banks & Savings0.3%

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Common Stock东方网 9 月 2日消息：据《劳动报》报道，阿里巴巴被视为史上最大 IPO，昨日有消息称，阿里巴巴预计在 9 月 8日当周稍早时间为首次公开发行举行市场热切期待的路演程序，其股票最早可能于本月月 18日或 19日上市。届时，马云或将成为中国的新首富。有分析指出，阿里此次在美整体上市，有望融资 200亿美元，这将会超过维萨卡公司 2008年的 196.5亿美元，成为美国历史上最大的公司上市融资案。

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Preferred Stock

Preferred Stock - Stock that takes priority over common stock in regards to dividends.

Net Worth - Book value of common shareholder’s equity plus preferred stock.

Floating-Rate Preferred - Preferred stock paying dividends that vary with short term interest rates.

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Corporate Debt

Debt has the unique feature of allowing the borrowers to walk away from their obligation to pay, in exchange for the assets of the company.

“Default Risk” is the term used to describe the likelihood that a firm will walk away from its obligation, either voluntarily or involuntarily.

“Bond Ratings”are issued on debt instruments to help investors assess the default risk of a firm.

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Corporate Debt

Prime Rate - Benchmark interest rate charged by banks.

Funded Debt - Debt with more than 1 year remaining to maturity.

Sinking Fund - Fund established to retire debt before maturity.

Callable Bond - Bond that may be repurchased by firm before maturity at specified call price.

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Corporate Debt

Subordinate Debt - Debt that may be repaid in bankruptcy only after senior debt is repaid.

Secured Debt - Debt that has first claim on specified collateral in the event of default.

Investment Grade - Bonds rated Baa or above by Moody’s or BBB or above by S&P.

Junk Bond - Bond with a rating below Baa or BBB.

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Corporate Debt

Eurodollars - Dollars held on deposit in a bank outside the United States.

Eurobond - Bond that is marketed internationally.

Private Placement - Sale of securities to a limited number of investors without a public offering.

Protective Covenants - Restriction on a firm to protect bondholders.

Lease - Long-term rental agreement.

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Convertible Securities

Warrant - Right to buy shares from a company at a stipulated price before a set date.

Convertible Bond - Bond that the holder may exchange for a specified amount of another security.

Convertibles are a combined security, consisting of both a bond and a call option.

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The Pecking Order Theory

Pecking order theory was first suggested by Donaldson in 1961 and it was modified by Stewart C. Myers and Nicolas Majluf in 1984.

Myers, Stewart C.; Majluf, Nicholas S. (1984). "Corporate financing and investment decisions when firms have information that investors do not have". Journal of Financial Economics 13 (2): 187–221.

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The Pecking Order Theory

Financing comes from three sources: internal funds, debt and new equity. Companies prioritize their sources of financing, first preferring internal financing, and then debt, lastly raising equity as a “last resort”.

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The Pecking Order Theory

张京等人（ 2009 ）通过比较我国上市公司与 G7 国家上市公司融资结构发现：我国上市公司的外源融资的比例为 61% ，比G7 国家外源融资比例最高的日本（ 56%）还高。在外源融资中，我国上市公司更偏重于股权融资，所占比例为 73% ，比G7 国家中外源融资比例最高的法国（ 61% ）还高。

数据来源：山西财经大学学报 2009 年第 4 期

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Summary

Corporate financing includes internal and external sources; plow back profits, issuing securities, bank loan, lease and so on patterns. Different sources and patterns influences corporate value differently. So ,financial manager must make financing decision to maximize stockholders’ wealth.

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questions

Why are the firms preferred to raise money by external sources rather than internal source in china?