Financial Decision Making Flashcards
Model of DEAN - Assumptions
- Certainty of future data
- Limited, known financing instruments and investment opportunities
- Financing instruments and investment opportunities are not mutually exclusive
- Financing instruments and investment opportunities can be realized independently
- Only monetary impacts are relevant
- Impacts can be assigned directly to the investment in terms of quantified inpayments and payouts
- Cash flows occur at the end of periods
- Required liquidity is available throughout the period
- Impact of taxes is disregarded
- Production program can be matched with investment opportunities
Financing-Matrix (Methods of Financing)
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Equity: ownership interest, raised through issuing stocks OR ownership interest in the company
Debt: borrowing money, repaid with interest
Investment-Financing: raising capital through investment
Subsidy-Financing: financial assistance provided by government/organizations
Credit-Financing: borrowing money, repaid with interest
Credit-Substitutes: alternative financing methods to credit
Bonds: borrowing money by issuing bonds, repaid with interest
Self-Financing: using profits to finance growth
Financing by Accruals: using non-cash accounting entries to finance growth
Financing by Regrouping of Investments: restructuring investments to finance growth
Credit Substitutes
Replaces borrowing, providing company with debt
Considered external financing
Constructions include: Leasing, Factoring, Asset Backed Securities
Credit Substitutes - Leasing Definition
Leasing company provides assets at predetermined leasing rates
No direct cash provided, considered a special type of debt financing
Types of Leasing
- Mobile Objects Leasing = allocation of mobile objects
- Property Leasing = allocation of property
- Personnel Leasing = allocation of personnel
- Equipment Leasing = allocation of equipment
- Consumer Goods Leasing = allocation of consumer good
Types of Leasing - Legal Status
Direct Leasing
Indirect Leasing
Direct Leasing - Functionality
Lessee and Lessor agree on lease object and contract
Lessor leases the object to the Lessee
Lessee pays a periodic leasing rate (fee) to the Lessor
Indirect Leasing - Functionality
- Lessee and vendor agree on lease object
- Lessor purchases the lease object at the request of the lessee
- Lessor leases the object to the lessee
- Lessee pays a periodic leasing rate to the lessor
Types of Leasing Contracts
- Operate Leasing Contracts: Withdrawal possible, no fixed term, lessor bears investment risk, lessor insures the lease object
- Finance Leasing Contracts: Fixed term, no withdrawal during contract period, lessee bears investment risk, lessee insures the lease object
Types of Leasing - Amortisation
Full-Amortisation Leasing: Leasing rates cover all costs plus a profit margin for the lessor
Partial-Amortisation Leasing: Leasing rates calculated to not amortise (value reduction over time) the lease object during the fixed term, lessor must find subsequent use for the object at the end of term
Scope for Design of Lease Contract
Option for prolongation at end of leasing period
Option for withdrawal from contract at end of agreed period
Purchase option at end of leasing period
Full-service option, including insurance and maintenance
Special Types of Leasing
Sale and Lease Back: Lessee sells already-purchased object to lessor and the lessor leases it back to the lessee
Cross Border-Leasing: Lessor and lessee based in different countries, advantageous in certain scenarios
Costs of Leasing
Depend on:
- Acquisition costs of lease object
- Amount of down payment
- Leasing period
- Residual value at end of leasing period
- Inclusion of further services (maintenance, insurance)
- Note: Leasing rates include the profit margin and administration costs of the leasing company.
Purchasing versus Leasing
Leasing rates are tax-deductible, reducing taxable income/profit
Depreciation: attributed to lessor
Leasing period is often shorter than depreciation period in purchasing
Payment: periodic in leasing, upfront in purchasing
Total leasing rates are higher than the purchase price
Cash discount: potential loss for lessee
Full-Amortisation Leasing: Lease Object Attribution
Lease object attributed to lessee if
* Leasing period > 90% of object’s useful life
* Leasing period < 40% of object’s useful life & first half lease rates significantly higher than second half
* Leasing period between 40% and 90% of object’s useful life & lessee has purchase or extension option
* Lease object specially made for lessee’s needs (“Specialised Leasing”)
Partial-Amortisation Leasing: Lease Object Attribution
Lease object attributed to lessee if:
* Leasing period and object’s useful life are approximately equal
* Lessee bears risk of value decrease/increase
* In case of specialised leasing
Consequences of “Hidden Purchase” in Leasing
Lease contract seen as purchase contract from income tax point of view
Lessee cannot deduct leasing rates from taxable income
Lessee must activate lease object and passivate a liability
Lessee can avail investing benefits
Lease object can be depreciated and the depreciation can be deducted from taxable income
Methods of financing
Methods of Financing:
- Self-Financing
- Financing by Depreciation
- Financing by Regrouping of Investments
- Financing by Accruals
- Credit-Financing
- Credit-Substitutes
- Bonds
- Investment-Financing
- Subsidy-Financing
Self-Financing
retained earings, withholding of profits, increase in equity
Financing by Depreciation
recording depreciation as a cost component on revenues
does not require cash payments, making it available to the company for financing purposes
Financing by Regrouping of Investments
Release of assets longer required for operating
-> capital for further investments
asset redistribution - sale of non-operating assets to release capital
Financing by Accruals
future liabilities appearing on balance sheet but are uncertain in their amount and due date
Estimation of accruals as of balance sheet date, but no payout yet, making the cash available for financing
reduce taxable profit and increase debt financing due to obligation and liability
Credit-Financing
creditors without acquiring ownership rights (debt financing)
Credit-Substitutes
Credit similar constructions e.g. leasing
Used to finance assets without direct ownership
Bonds
Contract between investors and issuer
amount is provided, agreed term and rate of interest
Total amount divided into partial bonds
Investment-Financing
private investor or group in exchange for partial ownership of the business
Subsidy-Financing
finance by the government to support a business activity
reduce the cost of investment and make the project able to generate sufficient profits
