WEEK 14:

FINANCIAL MANAGEMENT -2

BUSN 102 – Özge Can

Finding and Allocating Funds

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Financing Alternatives:

1) Debt Financing Arranging funding by borrowing money

2) Equity Financing Arranging funding by selling ownership shares in

the company, publicly or privately

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Criteria to Compare: Debt vs. Equity Maturity Claim on income Claim on assets Influence over management Tax consequences Employee benefit potential

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Debt Financing vs. Equity Financing

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Length of Term

Short-Term Financing Financing used to cover

current expenses Generally repaid within

a year

Long-Term Financing Financing used to

cover long-term expenses such as assets

Generally repaid over a period of more than one year

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Cost of Capital

Cost of Capital: Average rate of interest a firm pays on its combination of debt and equtiy

For any financing to make economic sense: Expected returns > Cost of capital

Cost of capital depends on three main factors: risk, interest rates, opportunity cost

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Interest Rates

Prime Interest Rate The lowest rate of interest that banks charge for

short-term loans to their most creditworthy customers

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Opportunity Cost

Leverage: The technique of increasing the rate of return on

an investment by financing it with borrowed funds

Capital Structure: A firm’s mix of debt and equity financing

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Financial Leverage: Example

Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

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Short-Term Debt Alternatives:

1. Credit Cards Short term loans by banks to card-holders

2. Trade Credit Credit obtained by a purchaser directly from a

supplier

3. Secured Loans Loans backed up with assets that the lender can

claim in case of default, such as a piece of property

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Short-Term Debt Alternatives:

4. Unsecured Loans Loans that require a good credit rating but no

collateral

5. Line of Credit An arrangement in which a financial institution

makes money available for use at any time after the loan has been approved

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Short-Term Debt Alternatives:

6. Commercial Paper Short-term promissory notes, or contractual

agreements, to repay a borrowed amount by a specified time with a specified interest rate

7. Factoring Obtaining funding by selling accounts receivable

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Sources of Long-Term Debt:

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Long-Term Debt Alternatives:

1. Long-Term Loans Bank or other lender provides the fund, borrower

agrees to repay within specific term (from 1 to 25 years)

2. Lease An agreement to use an asset in exchange for

regular payment; similar to renting

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Criteria for Long-Term Loans: “Five Cs”

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Long-Term Debt Alternatives:

3. Corporate Bonds A method of funding in which the issuer borrows

from an investor and provides a written promise to make regular interest payments and repay the borrowed amount in the future

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Key Types of Corporate Bonds:

Secured Bonds Bonds backed by specific assets that will be given to

bondholders if the borrowed amount is not repaid Debentures

Corporate bonds backed only by the reputation of the issuer

Convertible Bonds Corporate bonds that can be exchanged at the

owner’s discretion into common stock of the issuing company

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Equity

1. Private Equity Ownership assets that aren’t publicly traded;

includes venture capital and angel investors

2. Public Stock Offerings Offering shares of stock to the public through a

stock market

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Public Stock Offerings (IPOs)

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Public Stock Offerings (IPOs) Underwriter:

A specialized type of bank that buys the shares from the company preparing an IPO and sells them to investors

Prospectus: An SEC-required document that discloses

required information about the company, its finances, and its plans for using the money it hopes to raise

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Next Week – Our Last Session: Assignment #4: Submission Summary of Financial markets

and investment strategies (Textbook, Chapter 19)

Final Exam – Discussing of quiz#2 and other example questions

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