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Long-term financing 長期融資

Source of corporate long-term financing:

• long-term debts

• preferred stocks

• common stocks

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Main differences between debt and equity:• 1. Debt is not an ownership interest in the firm. Debtholde

rs have no voting rights.

• 2. Interest is fully tax deductible. Dividends are not tax deductible.

• 3. One cost of debt financing is the possibility of financial failure, resulting in bankruptcy. The result of bankruptcy is liquidation or reorganization.

Debt financing have the advantage of tax benefits and have the disadvantage of bankruptcy.

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Long-term Debt• A long-term debt is usually called a bond.

• Basic terms of the debt:Terms DescriptionAmount of issue $100 millionDate of issue 10/21/95Maturity 10/21/25Face value $1,000Annual coupon 10.50%Offer price 100Yield to maturity 10.50%Coupon paymentdates

12/31,6/30

Security NoneSinking funds AnnualCall provision not callable before

12/31/05Call price $1,100Rating Moody's rating Aaa

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Indenture: 債券契約• 1. The basic terms of the bonds.

• 2. The total amount of bonds issued.

• 3. A description of property used as security.

• 4. The repayment arrangements.

• 5. The call provisions.

• 6. Details of the protective covenants.

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Terms of a bond• Principal value• Registered form vs. bearer form• Security: collateral and mortgage

• Debenture: 信用債券 : A long-term bond that is not secured by a mortgage or a collateral. A debenture usually has a maturity of 10 years or more.

• Notes: Unsecured debt, usually with maturity under 10 years.

• Seniority: Seniority indicates preference in position over other lenders.

• Subordinated debenture: A bond has a claim on assets only after senior debt has been paid off in the vent of liquidation.

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• Deed of trust: Trustee is an official who ensures that the bondholders’ interests are protected and that the terms of the indenture are carried out.

• Sinking fund: A sinking fund provision requires the firm to retire a portion of the debt before maturity. The firm may be required to deposit money with a trustee. The trustee either buys up some of the bonds in the market or call in a fraction of the outstanding bonds.

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• The call provision: A call provision allows the firm to repurchase or call part or all of the bond issue at stated prices over a specific period. Corporate bonds are usually callable.

• Call premium is the amount by which the call price exceeds the par value of the bond.

• Deferred call: Call provision prohibiting the company from redeeming the bond prior to a certain date. During this period, the bond is said to be call protected.

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Protective covenants:

• Negative covenant: may not1. The firm must limit the amount of dividends it pays to stockholders.

2. The firm can not pledge any assets to other lenders.

3. The firm can not merger with another firm.

4. The firm can not sell or lease any major assets without approval by the lender.

5. The firm can not issue additional long-term debt.

• Positive covenant: must do1. The firm must maintain its working capital at or above some specified

minimum level.

2. The firm must periodically furnish audited financial statements to the lender.

3. The firm must maintain any collateral or security in good condition.

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Bond rating

Moody's Standard & Poors (S&P)Investment-qualitybond rating

Aaa AAA

Aa AAA ABaa BBB

Low-quality,speculative, and/orjunk bond rating

Ba, B BB, B

Caa CCCCa CCC CD D

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Other types of bonds

• Zero-coupon bonds (zeros):

• Floating-rate bonds: – floor and a ceiling: interest cap.

• Income bond

• Convertible bond

• Put bond

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Cost of long-term debt

• Cost of long-term debt is affected by• .loan maturity

• .Loan size

• .Borrower risk

• .Market rate

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Preferred Stock

• Stated value:

• Cumulative and noncumulative dividends

• Why firms issue preferred stocks?1. Firm issuing preferred stock can avoid the threat of bankru

ptcy.

2. Preferred shareholders have no voting rights.

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Common stock

• Common equity

• Par value

• Retained earnings

• Additional-paid in capital

• Book value per share

• Treasury stock: 庫藏股 : The share bought back are called treasury stock

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Shareholders’ rights

• Control of the firm

• Proxy:

• Proxy fight

• Takeover:

• The preemptive right:

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• Classified stock: Common stock that is given a special designation, such as Class A, Class B, and so forth, to meet special needs of the company.

• Funded shares: Stock owned by the firm’s founders that has sole voting rights but restricted dividends for a specified number of years.

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Factors affecting long-term financing decisions:1. Target capital structure:

2. Maturity matching

3. Interest rate level

4. The firm’s current and forecasted financial condition

5. Restrictions in existing debt contracts

6. Availability of collateral

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Issuing Securities to the Public IPO 首次公開上市 Alternative issue methods

• General cash offer: sell debt or equity directly to the public.

• Rights offer: sell equity to the firms’ existing stockholders.

• Initial public offering IPO (unseasoned new issue): A company’s first equity issue made available to the public.

• Seasoned new issue: A new equity issue of securities by a company that has previously issued securities to the public.

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Underwriter

a) Formulating the method used to issue the securities.

b) Pricing the new securities.

c) Selling the new securities.

• Syndicate: A group of underwriters formed to share the risk and to help sell an issue.

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Types of underwriting

• Firm commitment underwriting: underwriter buys the retire issue, assuming full financial responsibility for any unsold shares. Underwriter’s fee is the spread. All the risk associated with selling the issue is borne by the underwriter.

• Best efforts underwriting: Underwriter sells as much of the issue as possible, but can return any unsold shares to the issuer without financial responsibility. Underwriter acts as an agent for the issuer and receives a commission.

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• Spread

Compensation to the underwriter, determined by the difference between the underwriter’s buying price and offering price.

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The offering price and underpricing• If the issue is priced too high, it may be unsuccessful and h

ave to be withdrawn.

• If the issue is priced too low, the issuer’s existing shareholders will experience an opportunity loss.

• Underpricing is fairly common. Empirical works show that prices of new issued stocks increased by a dramatic amount right after the offering.

• Why does underpricing exist? To attract investors.

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Costs of issuing securities

• Spread:

• Other direct expenses:

• Indirect expenses.

• Abnormal return:

• Underpricing:

• Green Shoe option: The Green Shoe option gives the underwriters the right to buy additional shares at the offer price to cover overallotments.

• The total expenses of going public averaged 21.22% for firm commitment and 31.87% for best efforts.

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The effect of announcing new equity sales on firm value:• Stock prices tend to decline following the announcement

of a new equity issue, but they tend to not change much following a debt announcement.

1.Firms may attempt issue new shares of stock when they know the market value exceeds the correct value. Potential investors will learn that a firm’s stock price is too high once they hear the firm is going to issue new equity.

2.If the new project is a favorable one, why should the firm let new shareholders in on them? It could just issue debt and let the existing shareholders have all the gain.

3.High issuing costs.

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Advantage of going public

1.Facilitate stockholder diversification

2.Increase liquidity

3.Make it easier to raise new corporate cash.

4.Establishes a value for the firm.

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Dilution• Issuing new equity causes a loss in existing shareholders’

value, in terms of either ownership, book value, or market value.

a) Dilution of ownership: before (5000/50000)=0.1, after (5000/100000)=0.05

b) Dilution of book value: before: EPS=(NI/shares)=1 million/1 million=1, after EPS=(1.2 million/1.4 million)=0.857

• Dilution of market value: example: cost of project: 2 million, total market value of the firm increases from 5 million to 6 million. The NPV of the project is - 1 million. The loss per share is 1/1.4=0.71.