Documente Academic
Documente Profesional
Documente Cultură
SOURCES OF CAPITAL:
EQUITY AND DEBT FINANCING
(BMGT24: BASIC FINANCE)
SUBMITTED BY:
Bedeo,Pamela Ruth
Cagula, Marinelle
Orcullo, Darillyn Jhane
Pagalilauan, Edsil Lauren
Rabo, Sarah
BSBM-2D
SUBMITTED TO:
Ma’am Nora Capistrano
Sources of Capital
Retained earnings
Appropriated for:
Plant expansion Php 1,000,000
Un-appropriated 3,000,000 4,000,000
Total Stockholder’s Equity Php 8,200,000
Advantages of Equity as a source of capital by issuing ordinary shares
1. A company is not required to pay dividends to ordinary shareholders.
2. Ordinary shares do not have any maturity date.
3. The higher the proportion of equity in a company’s capital structure, the lower will be the risk
that creditors will suffer losses as a result of the borrower experiencing financial difficulty.
Disadvantages of Equity
1. If a company issues more ordinary shares to raise capital, existing shareholders will have to
either outlay additional cash or suffer some dilution of their ownership and control of the
company.
2. Dividends paid out of after-tax profit are generally subject to further taxation in the hands of
investors.
CAPITAL STOCK
Financing supplies permanent funds to the business through EQUITY or ownership channels
in the capital markets.
It is concerned with demand and supply in the stock markets.
The stock markets report what investors are willing to pay to become owners in a business.
FORMS OF CAPITAL STOCK
1. AUTHORIZED CAPITAL STOCK
the maximum number of shares that the business owners are allowed to issue.
2. ISSUED STOCK
is the amount of authorized stock subscribed to and paid for in cash, property or services.
3. REACQUIRED STOCK
can be reacquired in two ways:
a. by gift from stockholders;
b. by buying back some of the company’s issued stock
4. OUTSTANDING STOCK
is the portion of issued stock not reacquired
The contractual provisions of the stock forms for the following reasons:
Stock is authorized and issued on the basis of shares;
Stock is reacquired by the business in terms of shares;
Stock is voted on the basis of shares;
Profits are calculated on the basis of shares;
Dividends are declared on the basis of shares;
Stock purchase rights are distributed on the basis of outstanding shares;
Assets are distributed in liquidation on the basis of shares.
CLASSES OF STOCK
1. COMMON SHARES
Units of ownership registered in the names of the proprietors.
Rights and limitations are:
a. Right to vote or elect the board of directors of a corporation.
b. Right to share in profits and dividends as residual claimants after preferred shares; and
when management decides to pay dividends.
c. Pre-emptive common law right on issuance of common stock before selling to public.
d. Right to assets in liquidation, where right is pro-rata based, during voluntary or forced
liquidation.
2. PREFERRED SHARES
Issuance is indicated in the articles of incorporation.
Rights and limitations are:
a. No right to vote.
b. Right to share in profits and dividends.
DEBT FINANCING. Businesses can borrow from many sources, and the range of sources to choose
is generally related to the size of business.
Small business will usually have a relationship with one bank and will rely on that bank for most or
perhaps all of its debt finance.
Large companies are not restricted to borrowing from financial intermediaries and also issue
securities such as bills of exchange.
To illustrate the computation for Interest: Cost of borrowed capital = Interest x (1-tax rate)
Example:
Corporation Ruthy obtained a loan of Php 800,000 for a term of one year from RN Financing
Company at 20% interest. Rate of income tax is 35%.
It is advisable to use borrowed capital if its rate of return is higher than its cost.
If Delta Corporation is currently realizing a net income of Php. 300,000 on invested capital
of Php. 2,000,000 divided into 10,000 shares of capital stock with par of P hp 200,000,
The income from the project would show an increase in owner’s equity of 22.3% (from 15%).
Earnings per share will rise to Php. 44.60 (from Php. 30.00).
Owner’s equity remains at Php. 2,000,000, although an additional capital was made available from
creditors. The borrowed capital gave rise to an increase in rate of return on owner’s equity and the
earnings per share, but an increase in debt to equity ratio from 0:1 to .5:1.
Cash budgeting must provide for obligations to meet on loan maturity for payment of principal and
financing charges. This will not endanger the company’s financial stability.
Current status Proposed project Total of projections
Php 1,000,000 x 14.6%
Net income Php 300,000 Php 446,000
=Php 146,000
Owner’s equity 2,000,000 - 2,000,000
For example: would require the debtor to repay Php 1.10 on one year for every peso borrowed
today. Suppose a debtor was able to repay Php 25,000 in five years. On the part of the creditor,
who wants an interest rate of 12% on the loan, how much would be the amount to lend now? Or
what should be the amount of loan today, to get Php 25,000 on the fifth year?
This can be a discussion of time value of money, but for this purpose, below is the illustration:
Present Value =Php 25,000 / 1.7623 (refers to the Table on Future Value at the end of t periods)
=Php 14, 186
Treasury bills are pure discount loans. If a T-bill promises to repay Php 10,000 in 12 months, and the
market interest is 7%, how much will the bill sell in the market?
Present Value =Php 10,000 / 1.07
=Php 9,345.79
2) Interest-Only Loan
allows all debtor to pay interest each period and to repay the principal at some point in time. Notice
that if there is just one period, pure discount loans are the same. Most corporate bonds have the
general form of interest-only loan.
For example: With a three year, 10%, interest-only loans of Php 10,000,
The debtor would pay Php 10,000 x .10 = Php 1,000 in interest at the end of the first and second
year. At the end of the third year, the borrower would return the Php 10,000 along with another Php
1,000 in interest for that year.
3) Amortized Loan
requires the debtor to repay parts of the loan amount over time. The debtor pays the interest each
period plus fixed amount. The process provides loan payments on regular principal reduction.
For example: Suppose a business takes out a Php 50,000, five-year loan at 9%.
The loan agreement calls for the debtor to pay the interest loan on the balance each year and to
reduce the loan balance each year by Php 10,000.
Because the loan amount declines by Php 10,000 each year, it is fully paid in five years.
Beginning Ending
Year Principal Paid Interest Paid Total Payment
Balance Balance
1 Php 50,000 10,000 4,500 14,500 40,000
Notice that in each year, the interest paid is given by the beginning balance multiplied by the interest
rate. Also notice that the beginning balance is given by the ending balance from the previous year.
The most common way of amortizing a loan is to have the borrower make a single, fixed payment
every period. Almost all consumer loans, like car loans and mortgages, work this way.
For example: suppose our five-year, 9% Php 50,000 loan was amortized this way,
the illustration is as follows:
Amortization = Php 50,000
/ 3.8897 (refers to
Table on Present Value of Annuity for t periods)
= Php
12,845.46
The debtor will therefore make five equal payments of Php 12,854.46. On the first year, the interest is
Php 4,500; therefore total principal is Php 8,354.46. (Php. 12,854.46 - 4,500).
TYPES OF BONDS
A) ACCORDING TO TYPE OF SECURITY
1) SECURED BONDS or MORTGAGE BONDS
Are backed by the firm-owned property.
Most common type of secured bonds and backed by real estate assets.
If the firm defaults on its bond, the bondholders-represented by the trustee-could seize the
asset and sell it to settle the debt.
In some cases, if the bondholders are forced to sell the assets used as collateral, they may
receive liquidation value rather than the market value, and there may not be a guarantee that
the sale would cover the indebtedness of the issuing company.
Mortgage bonds are secured by a lien on specifically named property such as land, buildings,
equipment, and other fixed assets specifically pledge as security. Specific types are:
• Real estate which Real estate mortgages further sub-classes may include:
• Senior liens which have prior claim to fixed assets pledge as security, or sometimes called
first mortgage bonds
• Junior liens have subsequent claims to fixed assets pledge as security, or subordinate
claim to the senior liens. Also called second-mortgage or third-mortgage bonds
• includes land and property attached to the land.
• Chattel which consists of personal and movable property.
Also, real estate mortgage maybe classified according to type of issue:
• Closed-end issue wherein subsequent issues on the specific property pledge as collateral
are not allowed
• Open-end issue permits issuance of additional bond or series of issues to be made under
the original mortgage secured by a single lien.
• Limited open-end issue allows additional bonds to be sold after the original issue, but
stipulates a maximum amount. Issue becomes closed when the specified amount of bonds
have been issued.
2) DEBENTURES
Unsecured bonds longterm bonds of a corporation.
• More risky than secured bonds;
• Subordinate debentures are those with lower payment in hierarchy.
• Convertible bonds have stated maturity value and coupon rate, but it offers the investor the
opportunity to convert the debt to equity at stated periods of time.
• If stock prices appreciated, bondholders may be willing to convert.
For example: Akiko Manufacturing could offer a Php 1,000,000- 10-year bond, convertible into 20
shares of common stock on its fifth year. The firm may be benefit from the conversion feature
because convertible bonds carry a lower rate of interest than subordinate bonds without the
conversion feature.
3) Assumed bonds are those by the surviving corporation. They remain unchanged with the same
protection on mortgage lien given to the bond.
4) Guaranteed bond is a type in which payment of interest, or principal, or both, is guaranteed by
one or more individuals or corporations. This assures additional protection on the part of the
bondholder.
5) Joint bonds are owned by several companies. The same property may be used as security for a
bond issue. The companies bind themselves jointly as debtors in this issue.
All bonds can be classified as premium, par or discount bonds, depending on whether their current
price exceeds, is equal to, or is less than the face value. At maturity, the price o the bond must equal
the principal amount to be returned.
If a bond is selling at a premium, the price must fall toward face value as maturity approaches,
even if interest rates do not change.
If a bond is selling at a discount, the price must rise toward the face value as maturity
approaches, even if interest rates do not change.
The effect of a given change in interest rates on the price of the bond depends upon these variables:
o The maturity of the bond
o The coupon rate
o The level of interest rates at the time of the change in interests rates.
Interest Rate Risk
The threat that a bond’s price will change due to a change in interest rates.
The bonds prices move inversely with interest rates.
The price sensitivity of bonds increases with maturity, but it increases at a decreasing rate.
Forward rates of interest are rates for future time periods that are implied by currently available
spot rates. A spot rate is a yield prevailing at a given moment.
The risk structure of interest rates analyzes the differences in risk among different classes of
bonds.
The risk premium is the yield differential between risk-free treasury bonds and risky corporate
bonds.
Default risk is the chance that one or more promised payments on a security will be deferred to
miss altogether.