2. Content:
Introduction
Features
Types
Merit and Demerit
Use of Long term Debt in Financing Decisions
Use of Preferred Stock in Financing Decisions
Use of Long Term Debt in Financing
Use of Preferred Stock in Financing
Refunding Operation
Refunding Decision Process
Conclusion
3. Introduction
Long-term Debt Preferred Stock
Amount owed for a period exceeding
12 months from the date of the balance
sheet.
It could be in the form of a bank loan,
mortgage bonds, debenture, or other
obligations not due for one year.
A firm must disclose its long-term debt
in its balance sheet with its interest rate
and date of maturity.
It is important sources of financing.
A preferred stock is a class of
ownership in a corporation that has a
higher claim on its assets and earnings
than common stock.
Preferred shares generally have a
dividend that must be paid out before
dividends to common shareholders,
and the shares usually do not carry
voting rights.
It is a long term source of financing.
4. Features
Long term Debt Preferred Stock
Par Value
Coupon Interest rate
Maturity
Repayment Scheme
Tied up of collateral
Call Provision
Trustee
Conversion Features
Sinking Fund
Par value
Fixed Dividend
Maturity
Cumulative Features
Participating Features
Voting Rights
Claims on Asset and Income
Call Features
Conversion Features
Sinking Fund
5. Types and its definition
Long Term Debt
Bonds - A debt investment in which an investor loans money to an entity (typically
corporate or governmental) which borrows the funds for a defined period of time at
a variable or fixed interest rate. (Mortgage bond, Debenture, subordinated
Debenture, Income Bonds, Convertible Bonds, Callable Bonds, Portable Bonds)
Term Loan – A loan obtained from a bank from other financial institution for which
the borrower agrees to make a series of payment consisting of interest and principal
on specific date.
Debenture - A type of debt instrument that is not secured by physical assets or
collateral.
6. Merit and Demerit of Long-Term debt
Financing
Merit Demerit
Less Costly
Tax Saving and Interest Payment
More Flexible
No dilution in control power
No interference in business operation
Benefit of leverage can be entertain
Burden of Repayment
Risk High
Negative reputation on credit rating
Collateral may be required
Limited use of loan
Fixed Maturity
7. Merit and Demerit of Preferred Stock
Financing
Merits Demerits
No dilution in control power
Low risk
No Burden Of Repayment
Benefit of conversion can be taken by
company
No collateral
Difficulty to sale/Issue
No tax saving on interest payment
8. Use of Long term Debt in Financing
Decisions
Sales and earning are relatively stable.
Profit margin are adequate to make leverage advantages.
A rise in profits or the general price level is expected.
The existing debt ratio is relatively low
Profit margins are adequate to make leverage advantages.
Common stock price earning ratio are low in relation to the level of
interest rates.
9. Use of Preferred Stock in Financing
Decisions
If profit margins are adequate, the firm will gain from the additional
leverage provided by preferred stock.
Relative cost of alternative sources of financing are important.
When the use of debt involves excessive risk and issuance of common
stock poses control problem, preferred stock may be a good compromise.
10. Use of Long Term Debt in Financing
Equity Retention
Growth
Stability
11. Use of Preferred Stock in Financing
The corporate investor is attracted to preferred stock as
Flexibility in paying dividends and an infinite maturity (similar to a
perpetual loan) are significant advantages to the corporate issuer.
The after-tax cost of preferred financing is greater than that of long-term
debt financing to the corporate issuer.
12. Refunding Operation
The redemption of securities, typically debt, by raising more funds through
another offering. When a company conducts a refunding operation, it
recalls its existing bonds from the market. In exchange, a new bond issue is
sold.
The new issue is almost always issued at a lower rate of interest than the
refunded issue, ensuring significant reduction in interest expense for the
issuer.
13. Refunding Decision Process
Calculate the NPV of the refunding
Calculate the annual after tax Interest Saving
Calculate the Differential Annual tax saving on Flotation Cost
Calculate the initial outlay
14. Conclusion
A company issues different types of securities to raise capital because
different investors have different risk-return preferences.
When market interest rate decrease significantly, company can redeem
existing debt by issuing new debt.