Corporate financing Flashcards
What are two ways companies fund investment?
- Internal funds
- External funds
What are forms of internal funds
- Profits
- Depreciation
What are forms of external funds?
- New equity
- Borrowing
What proportion of corporate financing in the UK is taken up by internal funding?
2/3
Why is internal funding more convenient than external funding?
- Avoids costs of issuing new securities
- Avoids cost of negotiating debt
- Shareholders happy if dividends are used to increase stock value
When do managers usually rely too much on internal funds?
When they are averse to external funding and risk
What is the debt ratio?
Proportion of debt relative to the firm value
What is the formula for debt ratio?
Value of debt / (value of debt +Value of shares)
What is the calculation for the value of debt?
Current liabilities + Long term liabilities
What is book value?
Tells us how much capital the firm has raised from shareholders in the past
What is market value?
The value that shareholders place on those shares today
The market value of equity is often much larger than:
The book value of equity
The market debt ratio is often much lower than:
The book debt ratio
A corporation is owned by:
Its common stockholders
Corporations can raise new cash by issuing:
New stock
Stocks/shares held by investors are called:
Issued and outstanding
Stocks/shares that are bought back from investors are called:
Issued but not outstanding
What is the difference between stocks and shares?
Shares refer to ownership of one company, stocks refers to any company or more than one company
What type of rights do shareholders have?
Cash flow rights
Who do the privileged rights of shareholders go to?
Lenders of the firm
What types of the firm’s actions do shareholders have control over?
- Investment decisions
- Recruitment policy
- Decision to merge
Stockholders exercise their control rights by:
Voting
What type of vote do most decisions require to be approved?
Simple majority
What kind of vote result do some big decisions require?
Supermajority (75%)
Some shares can have the same cash flow rights, but different:
Control rights
Stocks with superior voting power sell at a:
Premium
What are the benefits of greater control rights?
- Prevent challenge to a position
- Extra bargaining power
- Business advantage
- Toss out bad management
The dividend rate on preferred stocks is fixed:
At the time of their issue
Preferred stock gives priority over common stock when:
Receiving dividends
When companies borrow money, their liability is:
Limited
Borrowers can walk away from debt obligations in exchange for:
Assets of the company
Borrowers are usually only willing to exchange assets in return for freedom of debt if:
Asset value < Debt value
What is the default risk?
Likelihood that a firm will walk away from its debt obligation
Bond ratings are issued on debt instruments to help investors assess the:
Default risk of a firm
Debt offers no control rights unless:
The firm defaults
Debt can be disguised as a:
Tax subsidy
Interest is paid on:
Pre tax income
Dividends are paid on:
After tax income
What is secured debt?
Debt that has first claim on specified collateral in the event of default
What is senior debt?
Debt a company must repay 1st if it goes out of business
What is subordinated debt?
Debt that must be paid in bankruptcy after senior debt is repaid
What classifies as Investment grade debt?
Bonds rated Baa or above by Moody’s or BBB or above by S&P
What’s a junk bond?
Bonds with a rating below Baa or BBB
What is a Callable bond?
Bonds that may be repurchased by the firm before maturity at a specified call price
What are convertible bonds?
Bonds that give its owner the option to exchange for shares
What do financial intermediaries do?
- Raise money from investors
- Provide financing for companies
What are the roles of financial markets?
- Payment mechanism
- Borrowing/lending
- Pooling risk
- Information
Debt ration measures the reliance on:
Debt vs Equity financing
