copyright by paradigm publishing, inc. introduction to business chapter 16 financing
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Copyright by Paradigm Publishing, Inc.
INTRODUCTION TO BUSINESS
CHAPTER 16
Financing
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Methods of Debt Financing
Debt financing: the act of borrowing funds. Capital: long-term funds
Borrowing from Financial Institutions Pledging Collateral Loan Rate Prime Rate: the rate of interest typically
charged on loans to the most creditworthy firms that borrow
Activity
How much money do you need to OPEN your business?
How are you going to get that money?
Options? (Name some…) Part of the feasibility section of
your report Let’s review the plan … Hand out– (quick review)
Costs
Initial (list – start up) Monthly – fixed, variable Break Even – www.javacalc.com Now that you know what you need
THEN you write the Feasibility section – Goes first in plan --
“Where’s the Money?”
Break Even Point (www.javacalc.com)
Start up costs – rough estimates
People: Hiring & training $
Lease
Inventory
Furniture
Computers/phones
Promotional costs
Office supplies
Other
TOTAL $
Monthly Costs – rough estimate
Payroll $
Rent
Inventory
Supplies
Utilities
Other
TOTAL
$
Revenue
A. Estimated days open per week x 4.3 weeks per month = _____ B. Estimated customers per day = ____ C. Estimated average customer sale (per mktg plan) = _____
A (days) x B (customers) x C ($) = Estimated monthly revenue of $_______________ per month
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Methods of Debt Financing
Fixed-Rate versus Floating-Rate Loans Types of Business Loans Loans Backed by the U.S. Government
Issuing Bonds Bonds: long-term debt securities (IOUs)
purchased by investors. Par Value: the amount that bondholders receive
at maturity.
Interest Rate Charged on LoansUnder Three Different Scenarios
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PRIME RATE
Wall Street Journal Prime Rate By Bankrate.com
This week Month ago Year ago 3.25 3.25 5.00 The initials stand for the Wall Street Journal, which surveys large banks
and publishes the consensus prime rate. The Journal surveys the 30 largest banks, and when three-quarters of them (23) change, the Journal changes its rate, effective on the day the Journal publishes the new rate. It's the most widely quoted measure of the prime rate, which is the rate at which banks will lend money to their most-favored customers. The prime rate will move up or down in lock step with changes by the Federal Reserve Board.
How it's used: The prime rate is an important index used by banks to set rates on many consumer loan products, such as credit cards or auto loans. If you see that the prime rate has gone up, your variable credit card rate will soon follow.
Summary of Risk Ratings Assigned by Bond Rating Agencies
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Methods of Debt Financing
Indenture: a legal document that explains the firm’s obligations to bondholders.
Secured bonds: bonds backed by collateral. Unsecured bonds: bonds that are not backed
by collateral. Call feature: provides the issuing firm with the
right to repurchase its bonds before maturity. Default Risk of Bonds
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Methods of Debt Financing
Protective covenants: restrictions imposed on specific financial policies of a firm that has issued bonds.
Issuing Commercial Paper: a short-term debt security normally issued by firms in good financial condition.
Impact of the Debt Financing Level on Interest Expenses
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Methods of Debt Financing
Common Creditors That Provide Debt Financing Commercial banks Savings institutions Finance companies Pension funds Insurance companies Mutual funds Bond mutual funds
Others…
Personal money –
“Skin in the Game” Love Money The Three “F”’s
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Methods of Equity Financing
Equity financing: the act of receiving investment from owners (by issuing stock or retaining earnings).
Retaining Earnings Dividend policy: the decision regarding how
much of the firm’s quarterly earnings should be retained (reinvested in the firm) versus distributed as dividends to owners.
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Methods of Equity Financing
Factors that Affect a Firm’s Dividend Policy Shareholder Expectations Firm’s Financing Needs
Issuing Stock Common stock: a security that represents
partial ownership of a particular firm. Preferred stock: a security that represents
partial ownership of a particular firm and offers specific priorities over common stock.
Methods of Equity Financing
When a business needs some equity funding but not enough to engage in a public stock offering, its owners may meet with representatives from venture capital firms. The owners will present their plan for how they would use the funds provided. The venture capital firms may extend funding if they think that they would receive a good return on their investment in the business.
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Methods of Equity Financing
Issuing Stock to Venture Capital Firms Venture capital firm: a firm composed of
individuals who invest in small businesses. Going Public
Initial public offering (IPO): the first issue of stock to the public.
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How Firms Issue Securities
Public offering: the selling of securities to the public.
Origination Underwriting
Underwritten: the investment bank guarantees a price to the issuing firm, no matter what price the securities are sold for.
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How Firms Issue Securities
Best-efforts basis: the investment bank does not guarantee a price to the firm issuing securities.
Underwriting syndicate: a group of investment banks that share the obligations of underwriting securities.
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Other Methods of Obtaining Funds
Financing from Suppliers Leasing: renting assets for a specified period
of time.
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Deciding the Capital Structure
Capital structure: the amount of debt versus equity financing.
Revising the Capital Structure How the Capital Structure Affects the Return
on Equity
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Remedies for Debt Problems
Extension: provides additional time for a firm to generate the necessary cash to cover its payments to its creditors.
Composition: specifies that a firm will provide its creditors with a portion of what they are owed.
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Remedies for Debt Problems
Private liquidation: creditors may informally request that a failing firm liquidate (sell) its assets and distribute the funds received from liquidation to them.
Formal Remedies Reorganization
Liquidation value: the amount of funds that would be received as a result of the liquidation of a firm.
Liquidation under Bankruptcy