Long term financing Flashcards
What are examples of long term financing
Financial (capital) Lease Preferred Stock Common Stock Bonds/ Bonds Payable Long term notes
Describe LT financing
Consists of sources that constitute capital structure (not financial structure).
Consists of sources on which the WACC is based.
Describe a Net-net lease agreement
the lessee assumes responsibility for both executory costs of the asset (insurance, taxes, maintenance) and for the asset having a pre-est. residual value at the end of the lease.
Describe a net lease agreement
The lessee assumes the executory costs associated with the asset during the lease, including such elements as maintenance, taxes, and insurance.
What are debt covenants?
they place contractual limitations on activities of the borrower to help protect the lender. As such, they reduce the default risk associated with a debt issue and reduce the interest rate on that debt.
What is a restrictive covenant
violation of such on a long tern note can trigger default.
What is the market price of a bond?
will be the present value of the principal amount plus the present value of future interest payments, all at the market(effective) rate of interest (whether the bond is issued at par, at a premium, or at a discount)
What kind of bond issues would have the highest interest rate risk, all other things being equal?
Bond issues with the longest maturity rate and lower stated interest rates. (ones with higher rates will fluctuate less with market fluctuations)
What type of bond is most likely to maintain a constant market value?
floating rate bonds. Because the interest rate changes with changes in the market rate of interest, they maintain a relatively stable market value.
Debenture bonds
Unsecured bonds. No specific asset is designated as collateral. These bonds are considered to have more risk and therefore must provide a greater return than secured bonds. They are more likely to have a higher coupon rate (interest rate) than comparable secured bonds.
Indenture
Contract that states the terms of a bond issued by a corporation
How are mortgage bonds secured?
by a lien on real property
Yield to maturity
(also called the expected rate of return) the rate of retun required by investors as implied by the current market price of the bonds. The current cost of capital for the firms bonds
Current Yield
the ratio of annual interest payments to the current market price of the bond.
Current yield ratio
annual coupon interest/ current market price
The price at which a bond will sell
the PV of its future interests payments plus the present value of its face value
Value of preferred stock equation
PSV = annual dividend / required rate of return
The expected rate of return on preferred stock
PSER = annual dividend / market price
What is the formula for Common Stock Expected return?
CSER = (dividend in 1st year / market price) + growth rate
What is the cost of capital for retained earnings
the same as the cost of capital for currently outstanding common stock
How is the theoretical value determined for a share of common stock that is to be held for multiple periods?
CSV = dividend in 1st year / (investors required rate of return - dividend growth rate)
(dividends are assumed to grow at a constant rate indefinitely)
How do you measure financial leverage?
the percentage change in EPS / the % change in earnings before interest and taxes
How can the optimal capitalization for an org usually be determined by?
the lowest total WACC
What type of source of new capital has the lowest after-tax cost?
Bonds - bc investors have less risk when investing in bonds than in equity. and bc interest payments to bondholders is deductible for tax purposes.
Why would a firm generally choose to finance temporary assets with short term debt?
short term needs should be financed with short term sources of financing bc matching the maturities of assets and liabilities reduces risk.
what type of financing generally has a lower interest rate?
short term financing
What is the effective cost of debt?
interest cost x (1 - tax rate)
