What are the primary sources of capital for a company requiring new capital?
- Retained earnings
- Commercial bank or finance company loans
- Lease financing
- Venture capitalists
- Equity issues (common stock and/or preferred stock)
- Debt issues (issuing bonds)
Why might small companies not be able to issue debt or shares to the public?
Issuing debt and shares incurs significant costs and there may be limited interest in smaller companies in the debt or equity markets.
What are term loans typically used for?
To purchase fixed assets such as equipment.
What is a commercial real estate loan?
A mortgage loan secured by commercial real property, such as an office building, factory, or warehouse.
What is lease financing?
A contractual agreement where the lessee has the right to use specific property for a specified period in return for periodic cash payments.
What are the advantages of leasing?
- Convenience - if an asset is needed for only a short time, a short-term lease is more practical than a purchase
- 100% financing available at fixed rates
- Depreciation tax shield benefit may be passed on by the leasing company
- Protection against obsolescence if the lessee is permitted to turn in an old piece of leased equipment for a new model at any time
- Flexibility - provisions may be less restrictive than those in other debt agreements
What are disadvantages of leasing?
- Cost - over the life of the asset, the total cash outlay associated with a lease may be greater than that associated with borrowing and purchasing the same asset.
- Lack of flexibility - if the lease is non-cancelable, it can cause a lack of flexibility.
What analysis is used to determine whether to lease or purchase equipment?
A cash flow analysis using discounted cash flow concepts.
What is the “net advantage to leasing” (NAV)?
The NAV is calculated as the present value of the differences between the annual after-tax cash outflows for purchasing with a loan and the annual after-tax cash outflows for leasing, discounted at the company’s after-tax borrowing rate.
What role do venture capitalists play in a young company?
They provide financing in exchange for ownership and often take active roles in advising and controlling the company.
What is an Initial Public Offering (IPO)?
An IPO is when a company first offers its common shares for sale to the public to raise capital.
What are the costs associated with going public?
Flotation costs such as filing fees, attorneys’ and accountants’ fees, and underwriting fees.
What is a primary offering of securities?
It is the initial sale of securities issued by a company and sold directly to investors. The proceeds from the sale go to the company and provide it with capital.
A primary offering may be either an IPO if it is the company’s first time offering securities to the public, or it may be a subsequent issuance of new securities by a company that is already publicly traded.
What is a secondary offering of securities in the context of an Initial Public Offering?
It is a sale of previously issued securities by one or more existing stockholders (rather than by the company) who want to liquidate all or part of their personal holdings. The proceeds go to the selling shareholders, not to the company.
A secondary offering may be a part of a company’s IPO, whereby insiders (founders, early investors, or institutional investors) offer their own shares to the public at the same time as the newly issued shares are being offered for the first time to the public.
What is a subsequent offering of securities?
It is any public offering of securities that occurs after the issuing company has had its initial public offering.
It is also called a follow-on offering or secondary public offering, which can cause confusion with the term “secondary offering.”
The shares sold to the public in a subsequent offering may be newly issued shares (a primary offering) or they may be existing shareholders selling their shares (a secondary offering), or they may be shares owned by the company and held in its treasury as treasury stock.
What are the three roles of an investment bank in assisting a company to issue its shares?
- Helps design the deal and securities
- Underwrites the new issue of securities
- Markets the issue to the public
What is underwriting in the context of issuing securities?
When an investment bank underwrites an issue of securities, it agrees to purchase some or all of the shares of the issuance and then reoffer them to the public.
What is a firm commitment in underwriting?
An arrangement where the underwriter absorbs any securities it cannot resell and receives a sizable fee for assuming this risk.
What is the underwriting spread?
The difference between the price at which the underwriter offers the securities to the public and the price at which it purchases them from the company.
What is a best-efforts agreement?
An agreement where the investment banker acts as an agent and markets the new issue of securities without committing to purchase any of the new shares.
What are the advantages of issuing bonds (debt financing)?
- No loss of control or ownership - the holders of the bonds are not owners and do not have any voice in the running of the company.
- Total cost is limited and known - the interest rate is constant throughout the life of the bond.
- Interest paid is tax-deductible
- Flexibility if bonds can be retired early
What are the disadvantages of issuing bonds (debt financing)?
- Less flexibility than equity because interest payments are fixed and required
- Increased risk because of possibility of default
- As the level of debt grows, the return required by not only the debt holders but also the company’s shareholders will increase
- Large future cash payout at maturity required
- Terms may include restrictive terms and covenants
What are the advantages of issuing common stock (equity financing)?
- No fixed payment required
- Shares do not require a fixed principal repayment
- Greater financial flexibility because no obligation to pay interest or principal
- Issuance of shares adds to equity and lowers debt-to-equity ratio
What are the disadvantages of issuing common stock (equity financing)?
- Limited number of shares can be issued as established in corporate charter
- As more shares are issued, the amount raised decreases because ownership and voting power of existing stockholders becomes more diluted
- Fees paid to investment bankers for the issuance of equity securities are usually higher than the fees paid for the issuance of debt securities.
- Added regulations and reporting requirements connected with going public
- Higher cost of capital than debt due to greater risk to investors
- Dividends are not tax-deductible
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A.1. Comparative Financial Statement Analysis11
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A.2. Financial Ratio Analysis150
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A.3. Profitability Analysis37
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A.4. Advanced Financial Topics60
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B.1. Risk and Return Fundamentals57
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B.2. Long-Term Financial Management124
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B.3. Raising Capital and Financial Markets38
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B.4. Working Capital Management105
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B.5. Corporate Restructuring and Valuation39
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B.6. International Finance68
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C.1. Cost-Volume-Profit (CVP) Analysis52
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C.2. Marginal Analysis and Decision Making57
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C.3. Pricing Decisions86
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D.1. Enterprise Risk Management (ERM)80
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E.1. Capital Investment Analysis and Cash Flows34
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E.2. Capital Investment Methods and Risk97
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F.1. Business Ethics and Fraud30
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F.2. IMA Code of Ethics and Fraud Triangle14
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F.3. Organizational Ethics and Culture64
