1 IIS Chapter 14 - Raising Capital in the Financial Markets Chapter 15 – Analysis and Impact of Leverage

2 IIS Tujuan Pembelajaran 1 Mahasiswa Mampu untuk: Memahami sumber dana internal dan eksternal Memahami bauran pembiayaan yang cenderung digunakan perusahaan Menjelaskan mengapa pasar keuangan timbul Menjelaskan komponen sistem pasar keuangan Memahami peran bankir investasi dalam perolehan modal Membedakan antara penawaran terbatas dan penawaran umum

3 IIS Pokok Bahasan 1 Sumber dana internal dan eksternal Bauran sekuritas perusahaan yang dijual di pasar modal Mengapa pasar keuangan muncul Pembiayaan perusahaan Komponen sistem pasar keuangan Bankir investasi Penawaran terbatas dan Penawaran umum

4 IIS Tujuan Pembelajaran 2 Mahasiswa mampu untuk: Memahami perbedaan antara risiko keuangan dan risiko bisnis Menggunakan teknik analisis titik impas untuk berbagai jenis analisis Membedakan konsep keuangan dari leverage operasi, leverage keuangan, dan leverage gabungan Menghitung degree of operating leverage, financial leverage, dan combined leverage

5 IIS Pokok Bahasan 2 Risiko bisnis dan keuangan Analisis titik impas Operating leverage Financial leverage Kombinasi operating leverage dan financial leverage

6 IIS Q: What are SECURITIES? A: Financial Assets that Investors purchase hoping to earn a high rate of return.

7 IIS Types of Securities Treasury Bills and Treasury Bonds Municipal Bonds Corporate Bonds Preferred Stocks Common Stocks Which of these are RISKY? Which promise HIGH RETURNS? Is there a relationship between RISK and RETURN?

8 IIS Corporate Financing Sources From 1999 through 2001, capital has been raised through the following sources: Corporate Bonds and Notes76.9% Equities23.1%

9 IIS Movement of Savings Direct Transfer of Funds cash securities saver firm

10 IIS Movement of Savings Indirect Transfer using Investment Banker securities fundsfunds securities saver investment banker firm

11 IIS Movement of Savings Indirect Transfer using a Financial Intermediary funds intermediarysecurities funds firmsecurities financial intermediary firm saver

12 IIS Financial Market Components Public Offering Firm issues securities, which are made available to both individual and institutional investors. Private Placement Securities are offered and sold to a limited number of investors.

13 IIS Financial Market Components Primary Market Market in which new issues of a security are sold to initial buyers. Secondary Market Market in which previously issued securities are traded.

14 IIS Financial Market Components Money Market Market for short-term debt instruments (maturity periods of one year or less). Capital Market Market for long-term securities (maturity greater than one year).

15 IIS Financial Market Components Organized Exchanges Buyers and sellers meet in one central location to conduct trades. Over-the-Counter (OTC) Securities dealers operate at many different locations across the country. Connected by Nasdaq system (National Association of Securities Dealers Automated Quotation system).

16 IIS Investment Banking How do investment bankers help firms issue securities? Underwriting the issue. Distributing the issue. Advising the firm.

17 IIS Distribution Methods Negotiated Purchase Issuing firm selects an investment banker to underwrite the issue. The firm and the investment banker negotiate the terms of the offer. Competitive Bid Several investment bankers bid for the right to underwrite the firm’s issue. The firm selects the banker offering the highest price.

18 IIS Distribution Methods Best Efforts Issue is not underwritten. Investment bank attempts to sell the issue for a commission. Privileged Subscription Investment banker helps market the new issue to a select group of investors. Usually targeted to current stockholders, employees, or customers.

19 IIS Distribution Methods Direct Sale Issuing firm sells the securities directly to the investing public. No investment banker is involved.

20 IIS Stock Issue Example: Our firm needs to raise approximately $100 million for expansion. Our stock price is $20. We Select Merrill Lynch to underwrite the issue for a 2% underwriting spread. What type of issue is this? It’s a negotiated purchase.

21 IIS Stock Issue Example: Our firm needs to raise approximately $100 million for expansion. Our stock price is $20. We Select Merrill Lynch to underwrite the issue for a 2% underwriting spread. How many shares will be sold? $100,000,000 / $20 = 5 million new shares of common stock.

22 IIS Stock Issue Example: Our firm needs to raise approximately $100 million for expansion. Our stock price is $20. We Select Merrill Lynch to underwrite the issue for a 2% underwriting spread. What are the flotation costs? Underwriting spread: 2% of $100 million = $2 million. Issuing costs: printing and engraving costs; legal, accounting, and trustee fees.

23 IIS Stock Issue Example: Our firm needs to raise approximately $100 million for expansion. Our stock price is $20. We Select Merrill Lynch to underwrite the issue for a 2% underwriting spread. What are the risks? The investment bank accepts the risk of being able to sell the new stock issue for $20 per share. If the stock price falls, the investment bank could lose money.

24 IIS Regulations: The Primary Market The Securities Act of 1933 Firms register with the Securities Exchange Commission (SEC). SEC has 20 days to review. SEC may ask for more information. The firm cannot solicit buyers during the review period but can advertise.

25 IIS Regulations: The Secondary Market The Securities Exchange Act of 1934 Established the SEC. Exchanges must register with SEC. Company information must be available to the public. Insider trading is regulated.

26 IIS Regulations: Recent Developments Securities Acts Amendments of 1975 Created National Market System. Eliminated fixed brokerage commissions. SEC Rule 415 Allows Shelf Registration

27 IIS Operating Leverage Financial Leverage Chapter 15 – Analysis and Impact of Leverage

28 IIS What is Leverage?

29 IIS What is Leverage?

30 IIS Two concepts that enhance our understanding of risk... 1) Operating Leverage - affects a firm’s business risk. 2) Financial Leverage - affects a firm’s financial risk.

31 IIS Business Risk The variability or uncertainty of a firm’s operating income (EBIT).

32 IIS Business Risk The variability or uncertainty of a firm’s operating income (EBIT). FIRM EBIT EPS Stock-holders

33 IIS Business Risk Affected by: Sales volume variability Competition Product diversification Operating leverage Growth prospects Size

34 IIS Operating Leverage The use of fixed operating costs as opposed to variable operating costs. A firm with relatively high fixed operating costs will experience more variable operating income if sales change.

35 IIS EBIT Operating Leverage

36 IIS Financial Risk The variability or uncertainty of a firm’s earnings per share (EPS) and the increased probability of insolvency that arises when a firm uses financial leverage.

37 IIS Financial Risk The variability or uncertainty of a firm’s earnings per share (EPS) and the increased probability of insolvency that arises when a firm uses financial leverage. FIRM EBIT EPS Stock-holders

38 IIS Financial Leverage The use of fixed-cost sources of financing (debt, preferred stock) rather than variable-cost sources (common stock).

39 IIS EPS Financial Leverage

40 IIS Breakeven Analysis Illustrates the effects of operating leverage. Useful for forecasting the profitability of a firm, division, or product line. Useful for analyzing the impact of changes in fixed costs, variable costs, and sales price.

41 IIS Quantity $ Total Revenue

42 IIS Costs Suppose the firm has both fixed operating costs (administrative salaries, insurance, rent, property tax) and variable operating costs (materials, labor, energy, packaging, sales commissions).

43 IIS Quantity { $ Total Revenue Total Cost FC Q1Q1 + - } EBIT

44 IIS Quantity { $ Total Revenue Total Cost FC Break-even point Q1Q1 + - } EBIT

45 IIS Operating Leverage What happens if the firm increases its fixed operating costs and reduces (or eliminates) its variable costs?

46 IIS Quantity { $ Total Revenue Total Cost = Fixed FC Break-even point } Q1Q1 + - EBIT

47 IIS With high operating leverage, an increase in sales produces a relatively larger increase in operating income.

48 IIS Quantity { $ Total Revenue Total Cost = Fixed FC Break- even point } Q1Q1 + - EBIT

49 IIS Quantity { $ Total Revenue Total Cost = Fixed FC Break- even point } Q1Q1 + - EBIT Trade-off: the firm has a higher breakeven point. If sales are not high enough, the firm will not meet its fixed expenses!

50 IIS Breakeven point (units of output) Q B = breakeven level of Q. F = total anticipated fixed costs. P = sales price per unit. V = variable cost per unit. Breakeven Calculations Q B = F P - V

51 IIS Breakeven point (sales dollars) S* = breakeven level of sales. F = total anticipated fixed costs. S = total sales. VC = total variable costs. Breakeven Calculations S* = F VC S 1 -

52 IIS Analytical Income Statement sales - variable costs - fixed costs operating income - interest EBT - taxes net income

53 IIS Degree of Operating Leverage (DOL) Operating leverage: by using fixed operating costs, a small change in sales revenue is magnified into a larger change in operating income. This “multiplier effect” is called the degree of operating leverage.

54 IIS DOLs = % change in EBIT % change in sales change in EBIT EBIT change in sales sales = Degree of Operating Leverage from Sales Level (S)

55 IIS If we have the data, we can use this formula: Degree of Operating Leverage from Sales Level (S) Q(P - V) Q(P - V) - F = DOLs = Sales - Variable Costs EBIT

56 IIS What does this tell us? If DOL = 2, then a 1% increase in sales will result in a 2% increase in operating income (EBIT). Stock- holders EBIT EPS Sales

57 IIS Degree of Financial Leverage (DFL) Financial leverage: by using fixed cost financing, a small change in operating income is magnified into a larger change in earnings per share. This “multiplier effect” is called the degree of financial leverage.

58 IIS DFL = % change in EPS % change in EBIT change in EPS EPS change in EBIT EBIT Degree of Financial Leverage =

59 IIS Degree of Financial Leverage DFL = EBIT EBIT - I If we have the data, we can use this formula:

60 IIS What does this tell us? If DFL = 3, then a 1% increase in operating income will result in a 3% increase in earnings per share. Stock- holders EBIT EPS Sales

61 IIS Degree of Combined Leverage (DCL) Combined leverage: by using operating leverage and financial leverage, a small change in sales is magnified into a larger change in earnings per share. This “multiplier effect” is called the degree of combined leverage.

62 IIS DCL = DOL x DFL Degree of Combined Leverage = % change in EPS % change in Sales change in EPS EPS change in Sales Sales =

63 IIS Degree of Combined Leverage If we have the data, we can use this formula: DCL = Sales - Variable Costs EBIT - I Q(P - V) Q(P - V) - F - I =

64 IIS What does this tell us? If DCL = 4, then a 1% increase in sales will result in a 4% increase in earnings per share.

65 IIS What does this tell us? If DCL = 4, then a 1% increase in sales will result in a 4% increase in earnings per share. Stock- holders EBIT EPS Sales

66 IIS In-class Project: Based on the following information on Levered Company, answer these questions: 1) If sales increase by 10%, what should happen to operating income? 2) If operating income increases by 10%, what should happen to EPS? 3) If sales increase by 10%, what should be the effect on EPS?

67 IIS Levered Company Sales (100,000 units)$1,400,000 Variable Costs $800,000 Fixed Costs $250,000 Interest paid $125,000 Tax rate 34% Common shares outstanding 100,000

68 IIS EPS Financial leverage Operating Income Sales Operating leverage Levered Company

69 IIS Degree of Operating Leverage from Sales Level (S) 1,400, ,000 1,400, , , ,000 = = DOLs = Sales - Variable Costs EBIT EBIT

70 IIS EPS Operating Income Sales Operating leverage 10% 17.14% Levered Company

71 IIS Degree of Financial Leverage DFL = EBIT EBIT EBIT - I = 350, , , ,000 = 1.556

72 IIS EPS Financial leverage Operating Income Sales 10% 15.56% Levered Company

73 IIS Degree of Combined Leverage DCL = Sales - Variable Costs Sales - Variable Costs EBIT - I EBIT - I 1,400, ,000 1,400, , , ,000 = =

74 IIS EPS Financial leverage Operating Income Sales 10% 26.67% Operating leverage Levered Company

75 IIS Sales (110,000 units)1,540,000 Variable Costs (880,000) Fixed Costs (250,000) EBIT 410,000 ( %) Interest (125,000) EBT 285,000 Taxes (34%) (96,900) Net Income 188,100 EPS $1.881 ( %) Levered Company 10% increase in sales

76 IIS Penutup Tugas