Ch 2, Module 1 Flashcards
How to corporations raise money?
An entity’s capital structure is the MIX of debt and equity
Define commercial paper
an unsecured, short term deb instrument issued by a corporation.
matures in 270 days or less, and 30 days is typically the maturity
proceeds from commercial paper must be used to finance current assets (such as AR or inventory, or to meet short term obligations
Define debentures
unsecured obligation of the issuing company. In the event of default, the holder of a debenture has the status of a general creditor
Define subordinated debentures
a bond issue that is unsecured and ranks BEHIND senior creditors in the event of an issuer liquidation.
Subordinated debentures command higher interest rates to justify the added risk
Define income bonds
securities that pay interest only upon achievement of target income levels
Junk bonds
characterized by high default risk and high return
“noninvestment grade” because they’re more likely to default on principal and/or interest payments
frequently used to raise capital for acquisitions and leveraged buyouts
Define mortgage bonds
a loan that is secured by residential or commercial real property
distinguishing factor of a mortgage bond - trustees act on behalf of bondholders to foreclose on mortgage assets in the event of default
What are the criteria in order for a lease to be classified as a “finance lease”
lessee must meet ONE of the following:
- Ownership transfer at the end of the lease
- Written purchase option that the lessee is reasonably certain to exercise
- Net present value of all lease payments and guaranteed residual value is equal to or substantially exceeds the underlying asset’s fair value
- Economic life of the underlying asset is primarily encompassed within the term of the lease
- Specialized asset such that it will not have an expected alternative use to the lessor when the lease ends
If none of the above criteria are met, or if the lease is short term (12 mo or less), it will be classified as an OPERATING LEASE
Define Preferred Stock
hybrid equity
has features similar to both debt and equity
preferred shares offer or require a fixed dividend payment to their holders, which is similar to coupon payments made on debt instruments. However the timing of the dividen payment is at the discretion of the board of directors (not mandatory) AND the dividend payments are not tax deductible
Preferred shares have cumulative dividends (dividends in arrears), a participating feature (where preferred shares may participate in declared dividends along with common shareholders), and voting rights in RARE circumstances
Define Common Stock
basic equity ownership security of a corporation
includes voting rights (with optional dividend payments by the issuer).
Define Weighted Average Cost of Capital
the average cost of all forms of financing used by a company
often used internally as a hurdle rate for capital investment decisions
What is the theoretical optimal capital structure?
the mix of financing instruments that produces the LOWEST WACC
