Presentation on Debt and Preferred Stock Financing

PRESENTED BY:RUPESH NYAUPANE

Content:

Introduction Features Types Merit and Demerit Use of Long term Debt in Financing Decisions Use of Preferred Stock in Financing Decisions Use of Long Term Debt in Financing Use of Preferred Stock in Financing Refunding Operation Refunding Decision Process Conclusion

Introduction

Long-term Debt Preferred Stock

Amount owed for a period exceeding 12 months from the date of the balance sheet.

It could be in the form of a bank

loan, mortgage bonds, debenture, or other obligations not due for one year.

A firm must disclose its long-term debt in its balance sheet with its interest rate and date of maturity.

It is important sources of financing.

A preferred stock is a class of ownership in a corporation that has a higher claim on its assets and earnings than common stock.

Preferred shares generally have a

dividend that must be paid out before dividends to common shareholders, and the shares usually do not carry voting rights.

It is a long term source of financing.

Features

Long term Debt Preferred Stock

Par Value Coupon Interest rate Maturity Repayment Scheme Tied up of collateral Call Provision Trustee Conversion Features Sinking Fund

Par value Fixed Dividend Maturity Cumulative Features Participating Features Voting Rights Claims on Asset and Income Call Features Conversion Features Sinking Fund

Types and its definition

Long Term Debt

Bonds - A debt investment in which an investor loans money to an entity (typically corporate or governmental) which borrows the funds for a defined period of time at a variable or fixed interest rate. (Mortgage bond, Debenture, subordinated Debenture, Income Bonds, Convertible Bonds, Callable Bonds, Portable Bonds)

Term Loan – A loan obtained from a bank from other financial institution for which the borrower agrees to make a series of payment consisting of interest and principal on specific date.

Debenture - A type of debt instrument that is not secured by physical assets or collateral.

Merit and Demerit of Long-Term debt Financing

Merit Demerit

Less Costly Tax Saving and Interest Payment More Flexible No dilution in control power No interference in business

operation Benefit of leverage can be

entertain

Burden of Repayment Risk High Negative reputation on credit

rating Collateral may be required Limited use of loan Fixed Maturity

Merit and Demerit of Preferred Stock Financing

Merits Demerits

No dilution in control power Low risk No Burden Of Repayment Benefit of conversion can be taken

by company No collateral

Difficulty to sale/Issue No tax saving on interest payment

Use of Long term Debt in Financing Decisions

Sales and earning are relatively stable. Profit margin are adequate to make leverage advantages. A rise in profits or the general price level is expected. The existing debt ratio is relatively low Profit margins are adequate to make leverage advantages. Common stock price earning ratio are low in relation to the level

of interest rates.

Use of Preferred Stock in Financing Decisions

If profit margins are adequate, the firm will gain from the additional leverage provided by preferred stock.

Relative cost of alternative sources of financing are important.

When the use of debt involves excessive risk and issuance of common stock poses control problem, preferred stock may be a good compromise.

Use of Long Term Debt in Financing

Equity Retention Growth Stability

Use of Preferred Stock in Financing

The corporate investor is attracted to preferred stock as Flexibility in paying dividends and an infinite maturity (similar to

a perpetual loan) are significant advantages to the corporate issuer.

The after-tax cost of preferred financing is greater than that of long-term debt financing to the corporate issuer.

Refunding Operation

The redemption of securities, typically debt, by raising more funds through another offering. When a company conducts a refunding operation, it recalls its existing bonds from the market. In exchange, a new bond issue is sold.

The new issue is almost always issued at a lower rate of interest than the refunded issue, ensuring significant reduction in interest expense for the issuer.

Refunding Decision Process

Calculate the NPV of the refunding

Calculate the annual after tax Interest Saving

Calculate the Differential Annual tax saving on Flotation Cost

Calculate the initial outlay

Conclusion

A company issues different types of securities to raise capital because different investors have different risk-return preferences.

When market interest rate decrease significantly, company can redeem existing debt by issuing new debt.