E2 - Corporate Financing

Question 1

How do companies finance their long-term investments?

(property etc)

Answer 1

Internal and External funding

Internal - profit and depreciation
External - new equity and borrowing

Question 2

In USA, Germany, Japan and UK what type of funding is most popular? Why?

Answer 2

Internal

It is far more convenient, avoiding costs of new security issuing / negotiating debt.

Question 3

How do you measure a firm’s reliance on debt and equity?

Answer 3

𝑑𝑒𝑏𝑡 𝑟𝑎𝑡𝑖𝑜= (𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑑𝑒𝑏𝑡)/(𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑑𝑒𝑏𝑡+𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑠ℎ𝑎𝑟𝑒𝑠)

- measures the proportion of debt relative to the firm’s value

Question 4

How do you measure debt?

Answer 4

current liabilities + long-term liabilities

Question 5

Book value vs market value

Answer 5

Book - how much capital firm has raised from shareholders in the past

market - measures the value that shareholders place on those shares today

Question 6

What are stocks held by investors called?

Answer 6

• issued and outstanding

Question 7

What are stocks that are bought back from investors called?

Answer 7

issued but NOT outstanding

Question 8

Explain how and why Facebook issued two classes of shares

Answer 8

When Facebook issued their first shares they were reluctant to give up control. Therefore, they issued A (to the public) and B (to the founders) shares. Both had the same cashflow rights but different control rights.

Question 9

Why do shares with a superior voting power sell at a premium?

Answer 9

• Greater control rights grant larger private benefits

Question 10

What is a preferred stock?

Answer 10

One that is given priority over common stock when receiving dividends

Question 11

What is a benefit of Debt?

Answer 11

It is a tax subsidy as interest is paid on pre-tax income and dividends on post-tax income

Question 12

When does debt offer control rights?

Answer 12

When the firm defaults

Question 13

Three types of debt cashflow claims?

Answer 13

Secured - first claim on specified collateral in default
Senior - priority to be paid in default
Subordinated - repaid after senior

Question 14

What are venture capital firms?

Answer 14

Pool funds from a variety of investors seeking out promising start-ups, working with them (quite intimately) as they grow

Question 15

Venture capital funds - investment policy:

Answer 15

• accept high uncertainty if there is potential
• identify failed investments early and accept loss rather than chasing it

Question 16

Outline the process of an IPO

Answer 16

1. selection of an underwriter (who resells securities to the public)
2. registration statement (for approval by SE authorities)
3. publication of prospectus (important info from registration statement)
4. road show to talk to potential investors
5. book building and setting appropriate issue price

Question 17

What costs are associated with IPOs?

Answer 17

• spread (paying underwriter through their markup)
• loads of admin costs
• hidden cost- underpricing of the IPO where people got it as a bargain

Question 18

After an IPO, how can shares be offered?

Answer 18

• general cash / public offer
• rights issue