Raising Debt and Leasing Flashcards
What are some characteristics of debt?
- Temporary contribution of capital
- Usually no voting rights
- Fixed and prior ranking contractual right to return on capital
- Fixed and prior ranking contractual right to return of capital
- Least risky form of capital
When a company borrows what are they obligated to do?
They are obligated to make regular interest payments and repay the principle at maturity
What do lenders get if a company defaults?
They get to take over the assets of the comapny
How do lenders get a say over decision making over a company?
They indirectly use covenants, both positive and negative, to protect themselves when lending
What types of debt are there?
There is bank debt and issued debt
What are some examples of bank debt?
- Bank overdraft (short term)
- Inventory loan (short term)
- Bridge loan (short term)
- Term loans (long term)
What are some examples of issued debt?
- Commercial paper, Bills of exchange (short term)
- Debentures (medium-long term)
- Corporate bonds (long term)
What types of debt covenants are there?
Negative covenants and positive covenants
What do positive covenants do?
Positive covenants ask borrows to do things as part of their contact. This includes activites such as maintaining assets and providing audited financial statements to the lender.
What do negative covenants do?
Negative covenants ask borrowers to avoid doing things as part of their contract. This includes limiting access to further debt, restrict holdings of certain inverstments and restrict dividend payout
How is firm value derived?
Debt + Equity = Firm Value
Under what conditions would equity be more valuable than debt?
Equity is more valuable if cash flows are more volitile. This gives shareholders more incentive to encourage risky projects
What projects to debtholders dislike?
The dislike risky projects as they try to avoid the risk of shareholders defaulting. This is reduced through covenants which reduce firm downside risk.
What is a lessor?
Legal owner/financer of asset
What is a lessee?
The asset user
What is a lease?
Contract where lessor recieves fixed payments from lessee in return for the use of the asset
What are the two types of leases?
There are operating leases and finance leases
What are some characteristics of operating leases?
- Like a rental agreement
- Cancellable by lessee at short notice typically without substantial penalty
- Risks of ownership borne by lessor
- Lessor is often a supplier of asset
- “Lease vs Buy” decision
What are some characteristics of financing leases?
- Long term agreement
- Non-cancellable without substantial penalty
- Risks of ownership transfered to lessee
- Lessor generally a financial institution
- Effectively lessor is a source of finance for lessee
- “Lease vs borrow-buy” decision
What is the discount rate for the NPV calculation?
interest rate x (1 - corporate tax rate)
How do you calculate the tax shield of lease payments?
lease payments x corporate tax rate
How do you calculate the tax shield of the depreciation?
depreciation x corporate tax rate
How to you calculate the tax on gain/loss on sale?
(residual - book value) x corporate tax rate
What sort of decision is is the decision to undertake a financial lease?
It’s a financial decision
