Week 3

Two Broad Sources of Long Term Financing

1. Internal Funding
2. Long Term Funding

What a Corporation needs to know

Can I Raise capital by issuing debt?

To who
At what cost
What are the non-financial implications?

Financing with Debt

ADV
- Tax deduction of interest payments
- Increase EPS if used wisely (investing it into assets to earn more than interest you pay)
- Lower overall cost of capital
- Maintain control over company
DISADV
- Contractual agreement
- Covenants can be restrictive
- Unwise use can lower share price
- Too much debt can hamper an economic downturn

Bank Financing (high restrictions)

Bonds

Corporations are the largest player in the Canadian Bond market

- Low interest rates make bonds worth it

Bond (a contract between the borrower and the lender)

Interest payment paid to the bondholders is called COUPON

The Payment at the maturity of the bond is called the par value typically $1000
Date at which the loan will be paid off is MATURITY DATE

Every bond begins with a legal document called a BOND INDENTURE outlining the terms and
description of the bond

SECURED: if the company doesn’t pay, the creditor has claim on those specific assets
UNSECURED is DEBENTURE – long term unsecured corporate bond

What the company can and cannot do:

- Negative Pledge – company limited in paying dividends

- Minimum Ratios – maintain debt/equity ratio

Seniority and Security do not guarantee payment.

Bonds are safer because there are assets attached to them..

DEFAULT RISK – is the likelihood that a firm will not satisfy its obligation to pay

Investment Grade Bonds

- Safer bonds
- BBB- and above

Junk Bonds
- BB+
- Higher return, higher risk

Public issue – issues debt to anyone who ishes to buy it

Private placement –

A bond is a series of contractual payments after their issue to initial investors, bonds trade
between investors in the secondary market.

Methods of Repayments
- Single sum
- Serial payments
- Sink fund provision (Company contributes to trust fund used to buy back
- Conversion
- Call Feature
- Refunding

Required Rate of Return

Real Rate of Return + Inflation premium = Risk-free rate
+Risk Premium = Required rate of return

Bond Price = PV of coupons + PV of final pmt

As interest rates in the economy change

Equity January 28, 2019

Big Picture

Companies need to expand modernize and introduce new products to purchase new assets

◦ Internal Funding
Rather than paying dividends, the firm can retain and plow back part of its
profits.
◦ External Funding
Firms can raise money from external sources by issuing financial securities
 debt
 equity

Common Shares

Private Corporation – shares held by small number of owners not to the public
Public Corporation – common shares available on the public market ie TSX

Financing with common equity

ADV
- no contract obligations
- possible when leverage is high
DIS
- significant cost
- dilutes earnings & control
- higher cost of capital (earn a return to compensate those shareholders)

If you’re going to raise capital by issuing more common shares you have to invest the capital to
grow the business and earnings back in

EPS = Net Income / # of Shares

Share Price: Market value of the shares determined by buyers and sellers

EPS: earnings per share

P / E Price Earnings Ratio. The share price divided by the earnings per share

Dividend: payments of the earnings of a company to the shareholders

Dividend Payout Ratio: proportion that gets payed out DPS / EPS
Plowback (Retention Ratio): proportion of earnings that a company retains and reinvests in the
company this = 1 – dividend payout ratio

Dividend Yield: Dividends per share divided by current share price

Sustainable Growth Rate: The rate at which a company can grow earnings and dividends. (ROE
* Plowback rate)

Preferred Shares are like Debt

 Pays a fixed dividend (like bonds) that must be paid before dividends on
Common Stock
 Preferred shares have no maturity date (like common equity)
 dividends are not tax deductible to a company and may be omitted without
triggering bankruptcy (like common equity)
 is considered a hybrid security. Has some characteristics of debt and some of
equity
 Preferred shareholders have no vote on company decisions and no claim on
residual assets of the business

February 4, 2019

Stock with a Low P/E Ratio

- Looks like a good buy
-

Stock with a high P/E Ratio

- Selling above par and is expected to do well but is selling at a premium

How to determine value of a company that doesn’t have earnings? A negative P/E

Consider: Market price/Sales