Chapter 14

Principles of Corporate Finance

Tenth Edition

An Overview of Corporate Financing

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

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Patterns of Corporate Financing

Firms may raise funds from external sources or plow back profits rather than distribute them to shareholders.
Retained earnings Debt issue Equity issue

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Should a firm elect external financing, they may choose between debt or equity sources.

Patterns of Corporate Financing

Internal funds
100%

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Net equity issues

Net borrowing

50%

0%

-50%

-100%

Patterns of Corporate Financing

Aggregate balance sheet for manufacturing corporations in the United States, 2008 (figures in Billions). Current assets Fixed assets Less deprecication Net fixed assets Other long term Total assets $ 2,749 1,459 1,291 3,515 6,843 2,037 Current liabilities Long term debt Other long term liabilities Total long term liabilities Stockholders' equity Total liabilities and stockholders' equity

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$ 1,578 1,385 1,105 2,490 2,775 6,843

Patterns of Corporate Financing

How do we define debt ?

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Debt 1,578 2,490 .59 Total assets 6,843

Long term liabilities 1,385 .33 Long term liabilities equity 1,385 2,775

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

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Market Debt Ratio

Book Debt Ratio

Debt Ratio, %

60% 50% 40% 30% 20% 10% 0%

Source: Board of Governors of the Federal Reserve System, Flow of Funds Table B.102

Patterns of Corporate Financing

80 70 60

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Debt Ratio (%)

50 40 30 20 10 0

Germany

Finland (2005)

Japan (2005)

Italy

France

Portugal

Spain

U.S.A (2005)

Netherlands

Belgium

Austria

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.

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Common Stock

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Example Honeywell Book Value vs. Market Value (Dec. 08) Total Shares outstanding = 735 million

Common Shares ($1 par) Additional paid in capital

958 3,994

Retained earnings 16,250 Treasury shares - 14,015 Other adjustments Net common equity (Book Value) 0 7,187

Common Stock

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Example Honeywell Book Value vs. Market Value (Dec. 08) Total Shares outstanding = 735 million

December 2008 Market price =

$35.00/sh

# of shares x 735 Market Value $25,725 million

Holdings of Corp Equities (2008)

Rest of World 11.7 Other 1.9 Households 35.7

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Mutual Funds, etc. 23.9 Insurance Companies 7.5

Pension Funds 19.2

Percent of Holdings

Common stock
Ownership of the corporation Cash flow rights Control rights Voting procedures Majority voting Cumulative voting Dual-class shares and private benefits Interest conflicts between majority and minority shareholders tunneling

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Preferred Stock
Preferred Stock - Stock that takes priority over common stock in regards to dividends. Net Worth - Book value of common shareholders equity plus preferred stock. Floating-Rate Preferred - Preferred stock paying dividends that vary with short term interest rates.

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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.

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Corporate Debt
Large firms issue many different securities. This table shows some of the debt securities on Honeywell's balance sheet in December 2008.

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US dollar debt Bank loans Commercial paper Notes Unsecured debentures Floating rate bonds Zero coupon bonds Money multiplier notes Industrial development bonds

Holdings of Corp Debt (2008)

Banks 4.5 Other 26.4 Households 10.9 Pension Funds 6.5

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Insurance Companies 19.9 Rest of World 21.3 Mutual Funds, etc. 10.5

Percent of Holdings

Financial Manager Questions

1. Should the company borrow short term or long term? 2. Should the debt be fixed or floating? 3. Should you borrow dollars or some other currency? 4. What promises should you make to the lender? Senior or junior; secured or unsecured 5. Should you issue straight or convertible bonds? Warrant; convertible

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Flow of savings to investment

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Financial markets and institutions

Financial Markets Used to raise money through primary issues Allow investors to trade amongst themselves Help firms manage risks Financial Intermediaries Raise money from investors, provide financing Banks, insurance companies, investment funds

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Financial markets and institutions

Investment Funds Mutual Fund

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Raises money by selling shares to investors Attempts to beat market

Money Market Fund

Invests in short-term safe securities

Closed-End Fund

Fixed number of shares

Financial markets and institutions

Financial Institutions Commercial banks Provide loans, safe money storage Investment banks Assist companies in raising financing Advise on takeovers, mergers, and acquisitions Insurance companies Invest in corporate stocks and bonds

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Web Resources
Click to access web sites Internet connection required

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www.census.gov/csd/qfr

www.federalreserve.gov/releases