F3 - 4/5. Equity and Debt Finance Flashcards
What are the 3 main short term sources of debt finance? (<1 year)
- Overdrafts
- Short term bank loans
- Commercial papers
What are the 3 main medium term sources of debt finance? (1-5 years)
- Med-term bank loans
- Medium term notes/floating rate notes
- Sale and lease back
What are the 3 main long term sources of debt finance? (>5 years)
- Bonds
- Convertible bonds
- Bonds with warrants
What are the 3 main sources of equity finance?
- Ordinary shares
- Preference shares
- Retained cash
What are 2 other possible sources of finance?
- Venture capital
- Government assistance
What does the share price represent in an efficient market?
The PV of future cash flows generated and returned to shareholders
What are 3 driving factors of share price movements, other than financial performance?
- Economic
- Industry
- Company announcements/changes
What is a rights issue?
Inviting existing shareholders to purchase shares in proportion to their existing shareholding, at a discount
What are the 3 options of shareholders when a rights issue is offered?
- Do nothing (value and % shareholding will fall)
- Sell rights (receive cash by % falls)
- Subscribe rights (maintain existing % shareholding)
What is the theoretical ex rights price?
The price at which the shares will theoretically settle immediately after the rights issue has been made
What impact does raising new shares for a project have on existing shareholders?
The issue price of new shares will determine how much of the gain from the new project goes to existing shareholders
What model can we use to estimate our cost of equity?
Dividend valuation model
How can growth in dividends be estimated? (2)
ROCE x proportion of funds reinvested into the business
OR
Historic growth
What is business risk?
The variability of profits before interest and tax
What are the 2 elements of business risk?
Systematic (macro economic) and specific (company specific)
How can specific risk be reduced?
Diversifying investments
What 2 things most impact systematic risk?
- Business sector
- Operational gearing
What does the B factor measure?
A company’s exposure to systematic business risk (the relative riskiness of the company compared to the market at a whole)
What is the capital asset pricing model?
The equation that links cost of equity, investors required return (considers risk free rate of return and market rate as a whole) and company’s risk Beta
When borrowing debt finance, what are the 5 key considerations for a company?
- Timescale (match to usage)
- Cost (interest)
- Liquidity (timing of repayments)
- Currency
- Interest type (variable or fixed)
When offering debt finance, what are the 6 key considerations for a lender?
- Security offered
- Timeframe (longer term = higher interest)
- Repayment profile (regular = lower interest)
- Amount requested
- Purpose
- Credit rating of borrower
What are the 2 types of security offered against debt?
- Fixed (particular assets)
- Floating (any assets up to set value)
What is a covenant?
Conditions against a loan that require the borrower to fulfil certain conditions, or perhaps restrit certain activities
What 3 things might happen if a covenant is breached?
- Terminate debt agreement
- Impose penalty payment
- Increase interest charges
