An Overview of Corporate Financing Principles of Corporate Finance Tenth Edition Chapter 14 An Overview of Corporate Financing Slides by Matthew Will McGraw-Hill/Irwin Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved. 1 1 1 1 1 2

Topics Covered Patterns of Corporate Financing Common Stock Debt Financial Markets and Institutions 2 2 2 2 3 2

Patterns of Corporate Financing Firms may raise funds from external sources or plow back profits rather than distribute them to shareholders. Should a firm elect external financing, they may choose between debt or equity sources. 20

Patterns of Corporate Financing

Patterns of Corporate Financing 20

Patterns of Corporate Financing How do we define debt ? 20

Debt to Net Worth for Non-Financial Firms, 1950-2008 Debt Ratios Debt to Net Worth for Non-Financial Firms, 1950-2008 Debt Ratio, %

Patterns of Corporate Financing

Common Stock Book Value vs. Market Value Book value is a backward looking measure. It tells us how much capital the firm has raised from shareholders in the past. It does not measure the value that shareholders place on those shares today. The market value of the firm is forward looking, it depends on the future dividends that shareholders expect to receive. 8

Common Stock Example – Honeywell Book Value vs. Market Value (Dec. ‘08) Total Shares outstanding = 735 million 9

Common Stock Example – Honeywell Book Value vs. Market Value (Dec. ‘08) Total Shares outstanding = 735 million 10

Holdings of Corp Equities (2008) Percent of Holdings

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. 14

Issues with Common Stock Who owns the corporation? Voting procedures Dual class shares and private benefits Partnerships Trusts REITs

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. 15

Corporate Debt

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. 16

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. 17

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. 18

Corporate Debt 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. 19

Holdings of Corp Debt (2008) Percent of Holdings

Financial Manager Questions Should the company borrow short term or long term? Should the debt be fixed or floating? Should you borrow dollars or some other currency? What promises should you make to the lender? Should you issue straight or convertible bonds?

Financial Markets Money Primary Markets OTC Markets Secondary Markets

Financial Institutions Company Obligations Funds Intermediaries Banks Insurance Cos. Brokerage Firms

Financial Institutions Intermediaries Obligations Funds Investors Depositors Policyholders

Web Resources Click to access web sites Internet connection required www.census.gov/csd/qfr www.federalreserve.gov/releases