Long term financing alternatives Flashcards
What are the two ways of external funding?
1) Equity financing- issuing securities
2) Debt financing- borrowing funds and public issue of debt
What are some examples of equity financing?
Cash offers- IPOs
Rights offers- seasoned new issues
What is the public placement of shares?
This is the public sale of shares done via investment banks.
Advantages of public placement
Greater liquidity and better access to capital
Disadvantages of public placement
Equity holders become more widely dispersed and the firm must satisfy all the requirements of public companies
Steps of public placement
1) Banks act as underwriters and buy all the shares from a company
2) The shares are purchased by investment banks at the day of the public offering at a lower price
3) Then they either offer the shares with a fixed price to the public (firm commitment) or via uniform price auction (dutch auction underwriting)
How to find the spread for public placement?
Offering price - underwriter’s price = spread
Issues with public placement
1) Underpricing: even though closing price is higher it is usually less than the true value of the firm.
2) Overvaluation: issuing shares may signal private information that firm is overvalued.
3) Fear of financial distress: issuing shares could signal financial distress which means investors choose to pay less than true value.
4) Overpricing: firm fears offer price is too low leading to a lot of money left on the table so they offer higher price. Invetsors don’t trade which pushes closing price lower.
Formula for money left on the table
Closing price - offering price
Formula for underpricing
Market price - Closing price
Formula for initial return of IPOs
(Closing price- Offer price)/ Offer price
What is a private placement of shares?
The firm contacts private equity firms who will act as underwriters who sell shares to institutional investors, insurance firms, pension fund companies etc.
Explain rights offers
There is still underwriters but this time they contact only current shareholders of the firm despite the announcement being made public. They are offered at a lower price for limited time and unsold shares expire and stay within the firm.
Explain the types of bank loans
1) Line of credit- the bank agrees to lend money to the firm with a limit on the amount borrowed. However, no fixed interest.
2) Loan commitment- a similar contract where the interest rate is pre-determined
3) Revolving loan commitment- firm pays down the loan and borrows more
4) Non-revloving loan- fund flow restricted
What are some examples of debt financing?
1) Corporate bonds
2) Bank loans
3) Bond refunding
Explain how corporate bonds work
A firm appoints a trust to manage bonds. They are offered at face value and an interest rate for term of maturity. The firm shows property as collateral.
Types of debt covenants
Negative and positive
What are the positive protective covenants?
- Limits on merging with other firms
- Limits on dividend payment to shareholders
- Limits on issuing additional debt
- Disclosure of financial statements to lenders
Formula for call premium
Call price - face value
What is bond refunding?
Callable bonds where the company can repurchase bonds and issue new bonds simultaneously.
Why choose to bond refund?
When the firm has superior knowledge of what future interest rates are or tax advantages. However, this means call premium and coupon payments are high to attract bondholders.
