Corporate Financing Flashcards
How do companies finance their investment?
Internal/External funds (outsider investors).
Companies need to raise capital in order to invest in new projects and grow.
Retained earnings (internal), debt capital, and equity capital (external) are three ways companies can raise capital.
Companies raise debt capital by borrowing from lenders and by issuing corporate debt in the form of bonds.
Equity capital, which comes from external investors, costs nothing but has no tax benefits.
Why is internal funding more convenient than external?
Avoids costs of issuing new securities.
Shareholders happy if retained earnings finance positive NPV investments. They give up some dividends (income to shareholders) but the stock has greater market value because of investment.
What is more effective for small start up company, internal or external funding?
Internal financing is easier to obtain for established businesses that may already have stock or assets.
External financing can be vitally important for small and start-up businesses that need a cash inflow in order to get off the ground.
What are the three main securities that companies issue?
A Security is a tradeable financial asset that holds a monetary value.
Divided into debt and equity securities.
Three main types are Common stock, Preferred stock, Debt.
What is the difference between debt and equity securities?
Debt securities include corporate bonds (debt), while equity securities include common and preferred stocks.
Control and cashflow rights differ. Debt have no control rights.
What is the debt ratio?
Proportion of debt relatively to the firm value.
Measures the reliance on dbet vs equity financing.
What is the difference between Book value and Market value?
Book value: tells us how much capital the firm has raised from shareholders in the past (accounting
value)
Market value: measures the value that shareholders place on those shares today.
Market value of equity is often larger than the book value of equity.
What are common stocks and what is the difference between outstanding and non outstanding?
Shares entitling their holder to dividends.
A corp is owned by its common stockholders and corps can raise new cash by issuing new stock.
Stocks held by investors are called issued and outstanding.
Stocks that are bought back from investors are called issued but not outstanding.
How do shares relate to ownership?
Shareholders have control rights over firms affairs, e.g., investment decisions, recruitment policy, decision to merge, etc.
In widely held corporations, common stockholders’ control is limited or restricted to
the individual entitlement to vote.
Dividends and control rights are limited in case firm goes into bankruptcy.
Give an example of how common stocks and voting rights work.
Facebook founders were reluctant to give up control
of the company. Therefore, the company created two classes of
shares. The A shares, which were sold to the public, had 1 vote each, while the B shares, which were owned by the founders, had 10 votes each. Both classes of shares had the same cash-flow rights, but they had different control rights.
Why do stocks with superior voting power sell at a premium?
They give greater control rights that grant larger private benefits.
They prevent challenge to their management position.
Can lead to getting rid of bad management or force management to adopt policies that enhance shareholder value.
What are Preferred Stock?
A share which entitles the holder to a fixed dividend. Dividend rate is fixed at the time of their issue.
They give priority over common stock when receiving dividends. Common stockholders don’t receive anything until preferred stockholders receive theirs.
They don’t give ownership right unless company fails to pay preferred dividend.
What is corporate debt?
Corporate debts are the debts borrowed by companies for business purposes. The most common instrument of corporate debt is a Bond. A company can raise funds by selling bonds.
They promise to make regular interest payments and to repay principal.
What is default risk?
Is the probability that a borrower (corporation) fails to make full and timely payments of principal and interest to lender. (BONDS and DEBT)
Are Debt and control rights linked?
Debt offers no control rights as lenders arent owners.
