The Great Pelebeian college G12 Business Finance

SY 2020-2021

G12 BUSINESS FINANCE

MODULE
SOURCE AND USES OF SHORT-TERM AND LONG TERM FUNDS

MODULE MAP

Expected Skills
1. Identify the difference sources of short-term and long-term financing.
2. Differentiate debt financing form equity financing.
3. Understand the advantage and disadvantage of the different source of financing.
4. Identify the more appreciate source of financing given a funding requirement.
5. Know the obligation of the barrowers to their creditors.

EXPECTED SKILLS

lesson 1

Definition and nature of planning

PLANNING- is the first management function and for good reason. It is a crucial and essential
part of management. Planning is important for the fallowing reason.

1. Planning provides directions to all of the organization’s human resources both managers as
well as employees
2. Planning is important because it reduces uncertainty; it compels manager to consider future
events that may affect their company.
3. Minimizing of wastes will result if there is proper coordination’s of activities due to planning;
negative practices, ineffectiveness, and inefficiencies could be easily detected and can be
corrected and eliminated.
4. Establishing goals and standards during planning may be used for controlling, another
necessary managerial function.

TYPES OF PLAN

STRATEGIC PLANS- Plans that establish the organization overall goals and apply to the entire
firm; they are broad in scope and are the responsibility of the CEO, president, and the general
manager of the company.
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SY 2020-2021

OPERATIONAL PLANS- plans that apply to a particular unit area only; their scope is narrow;
achievement of the company goal may not be achieved if operational plans are not clear.

LONG TERM PLANS- plans that go beyond three years; everyone must understand the
organizations long term plans to avoid confusions that me be divert the organization member’s
attention.

Short Term Plans- plans that cover one year or less; such plans must lead toward ate
attainment of long-term goals and are the responsibility of the unit/department heads.

DIRECTIONAL PLANS- plans that are flexible or give general guidelines only; although flexible
and general, these plans must still be related to strategic plans.

SPECIFIC PLANS- plans used or stated or stated and which have no room for interpretation;
language used must be must be very understandable.

SINGLE-USE PLAN- plans used or stated and which have no room for entire organization; refer
to strategic plans of the firm.

STANDING PLANS- plans that are ongoing; provide guidance for different activities done
repeatedly; refer to identified activities of operational plans.

PLANNING AT DIFFERENT LEVELS IN THE FIRM

Different levels in the firm are all engaged in planning; however all the resulting plans must be
related to one another and directed toward the same goals.

Debt and Equity Financing

Source of financing are divide into two major categories: debt Financing and Equity
Financing. The following Section Describe the features of each source.

Debt Financing

Debt financing is what happens when a business borrows money in order to operate.

Some examples of debt financing include:

 Traditional bank loans

 Personal loans
 Loans from family or friends
 Government loans, including Small Business Administration (SBA) loans
 Peer-to-peer loans
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SY 2020-2021

 Home equity loans

 Lines of credit
 Credit cards
 Equipment loans

Advantages

 Retain control. When you agree to debt financing from a lending institution, the lender
has no say in how you manage your company. You make all the decisions. The
business relationship ends once you have repaid the loan in full.

 Tax advantage. The amount you pay in interest is tax deductible, effectively reducing
your net obligation.

 Easier planning. You know well in advance exactly how much principal and interest you
will pay back each month. This makes it easier to budget and make financial plans.

Disadvantages
Debt financing has its limitations and drawbacks.
 

 Qualification requirements. You need a good enough credit rating to receive financing.

 Discipline. You’ll need to have the financial discipline to make repayments on time.

Exercise restraint and use good financial judgment when you use debt. A business that
is overly dependent on debt could be seen as ‘high risk’ by potential investors, and that
could limit access to equity financing at some point.

 Collateral. By agreeing to provide collateral to the lender, you could put some business
assets at potential risk. You might also be asked to personally guarantee the loan,
potentially putting your own assets at risk.

Equity Financing

Equity financing is the process of raising capital through the sale of shares. Companies
raise money because they might have a short-term need to pay bills, or they might have
a long-term goal and require funds to invest in their growth. By selling shares, a
company is effectively selling ownership in their company in return for cash.

Advantages

 Less burden. With equity financing, there is no loan to repay. The business doesn’t have
to make a monthly loan payment which can be particularly important if the business
doesn’t initially generate a profit. This in turn, gives you the freedom to channel more
money into your growing business.
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SY 2020-2021

 Credit issues gone. If you lack creditworthiness – through a poor credit history or lack of
a financial track record – equity can be preferable or more suitable than debt financing.

 Learn and gain from partners. With equity financing, you might form informal
partnerships with more knowledgeable or experienced individuals. Some might be well-
connected, allowing your business to potentially benefit from their knowledge and their
business network.

Disadvantages

 Share profit. Your investors will expect – and deserve – a piece of your profits. However,
it could be a worthwhile trade-off if you are benefiting from the value they bring as
financial backers and/or their business acumen and experience.

 Loss of control. The price to pay for equity financing and all of its potential advantages is
that you need to share control of the company.

 Potential conflict. Sharing ownership and having to work with others could lead to some
tension and even conflict if there are differences in vision, management style and ways
of running the business. It can be an issue to consider carefully.

SOURCES AND USES OF SHORT TERM FUNDS

Short-term funds are normally used to finance the day-to-day operations of the
company. It is used for working capital requirements such as account relievable and
inventories.

The following can be sources of short-term funds:

 1. Suppliers credits. Suppliers of raw materials and merchandise are the best sources of
short-term capital.

2. Advances from stockholders. If you have enough personal assets and you control the
company, advancing funds to the company when there are financial requirements is an
easy way for the company to raise funds.

3. Credit cooperatives. To barrow form credit cooperatives, you have to be a member.

Credit cooperative can lend as much as five times of your equity or contributions.

4. Bank loans. Banks can provide both short-term and long-term loans. Some banks
also provide credit facilities, not just to big corporations, but also to also and medium
enterprises.

5.Lending companies. These are small lending companies which cater normally to small
and medium enterprises.

6.Informal lending sources such as “5-6”. This is very expensive source of financing and
should be avoided.

SOURCES AND USES OF LONG TERM FUNDS

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SY 2020-2021

Long-term funds are used for long term investment or sometimes called capital
investment. This includes expansions, buying new equipment, or buying a piece of land
which will be the site of future expansions. Long-term funds can also be used to finance
permanent working capital requirements.

The following can be sources of long-term funds:

1. Equity investors. Equity investors can be issued common stocks. This is the most
patient source of capital.

2. Internally generated funds. Instead of declaring cash dividends, the company can use
internally generated funds for expansions or to finance other types of capital
investments.

3. Banks. Banks are sources of different types of financing from short-term to long-term.

4. Bond market. The market is gaining more popularity among our big publicity listed
companies for their fundraising activities.

5. Lending companies. These are the same lending companies previously discussed.
some of them also provide long-term loans ranging from two to five years.

Duties of the borrower to Creditors

1. Pay the creditors based on the payment schedule agreed upon.

2. Provide the collaterals as agreed upon in the loan negotiation with proper
documentations, if necessary and if applicable (e.g., annotation of the Transfer
certification of title (TCT) or condominium certificate of title (CCT).

3. Comply with the provisions of the loan covenant such as maintaining certain liquidity
and leverage rations.

4. Notify the creditor if the company is acquiring another company or the company is
now the subject of acquisition.

5. Do not default on the loan as much as possible.

Exercises

1. Discuss how the following companies coming from different sectors should finance (capital
structure) and why.
A. Property company like Robinsons Land Corporation (RLC)
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SY 2020-2021

B. Utility company like PLDT

C. Food company like Jollibee Food Corporation.
D. Mining company like Philex Mining Corporation.

2. The fallowing excerpt was taken from an article published on April 7 &, 2015 in the
Philippines Star:
“Ayala Land Inc. (ALI) has started the ball rolling for its planned PHP. 7-billions debt sale to
partially finance its record PHP. 100-billion capital expenditures (capex) this year.”
Discuss the possible effects of this financing on the capital structure of Ayala Land, Inc. How will
this Financing affect the statement of profit or loss of Ayala Land, Inc.?

3. The following expert was taken from an article published in Inquirer.net on February 10, 2015:
“Infrastructure holding firm Metro Pacific Investments Corp. has raised $200 million in
fresh funds from expansion through an overnight equity private placement deal”?
According to the management, proceed from this fundraising activity will be used to
retire the more expensive debt of its affiliate, Beacon Electric Asset Holdings, Inc.

Metro Pacific Investment Corp. (MPIC) is the holding company behind Meralco, NLEX,
Maynilad, and hospitals like Makati Medical Center.

Discuss how this fundraising activity will affect the statement of financial position of
MPIC. How will this affect the financial position and profitability of its affiliate, Beacon Electric
Asset Holdings,Inc?
The Great Pelebeian college G12 Business Finance
SY 2020-2021

G12 BUSINESS FINANCE

MODULE
BASIC AND LONG-TERM FINANCIAL CONCEPTS

EXPECTED SKILSS

1. Calculate the future value and present value money.

2. Compute the effective annual interest rate.
3. Compute loan amotorization using mathematical concepts and present value tables.
4. Apply mathematical concepts and tools in deciding on financing and investment problems.

What is ‘Risk and Return’?

In investing, risk and return are highly correlated. Increased potential returns on investment
usually go hand-in-hand with increased risk. Different types of risks include project-specific risk,
industry-specific risk, competitive risk, international risk, and market risk. Return refers to either
gains and losses made from trading a security.
The return on an investment is expressed as a percentage and considered a random variable
that takes any value within a given range. Several factors influence the type of returns that
investors can expect from trading in the markets.

Diversification allows investors to reduce the overall risk associated with their portfolio but may limit
potential returns. Making investments in only one market sector may, if that sector significantly
outperforms the overall market, generate superior returns, but should the sector decline then you may
experience lower returns than could have been achieved with a broadly diversified portfolio.

How Diversification Reduces or Eliminates Firm-Specific Risk

First, each investment in a diversified portfolio represents only a small percentage of that

portfolio. Thus, any risk that increases or reduces the value of that particular investment or
group of investments will only have a small impact on the overall portfolio.
Second, the effects of firm-specific actions on the prices of individual assets in a portfolio can be
either positive or negative for each asset for any period. Thus, in large portfolios, it can be
reasonably argued that positive and negative factors will average out so as not to affect the
overall risk level of the total portfolio.
The benefits of diversification can also be shown mathematically:
σ^2portfolio= WA^2σA^2 + WB^2σB^2 + 2WA WBр ABσ AσB
Where:
σ = standard deviation
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SY 2020-2021

W = weight of the investment

A = asset A
B = asset B
р = covariance
Other things remaining equal, the higher the correlation in returns between two assets, the
smaller are the potential benefits from diversification.

 Comparative Analysis of Risk and Return Models

The Capital Asset Pricing Model (CAPM)

APM
Multifactor model
Proxy models
Accounting and debt-based models
For investments with equity risk, the risk is best measured by looking at the variance of actual
returns around the expected return. In the CAPM, exposure to market risk is measured by a
market beta. The APM and the multifactor model allow for examining multiple sources of market
risk and estimate betas for an investment relative to each source. Regression or proxy model for
risk looks for firm characteristics, such as size, that have been correlated with high returns in the
past and uses them to measure market risk.
On investments with default risk, the risk is measured by the likelihood that the promised cash
flows might not be delivered. Investments with higher default risk usually charge higher interest
rates, and the premium that we demand over a riskless rate is called the default premium. Even
in the absence of ratings, interest rates will include a default premium that reflects the lenders’
assessments of default risk. These default risk-adjusted interest rates represent the cost of
borrowing or debt for a business.

Time Value of Money

If you're like most people, you would choose to receive the $10,000 now. After all, three years is
a long time to wait. Why would any rational person defer payment into the future when they
could have the same amount of money now? For most of us, taking the money in the present is
just plain instinctive. So at the most basic level, the time value of money demonstrates that all
things being equal, it seems better to have money now rather than later.

But why is this? A $100 bill has the same value as a $100 bill one year from now, doesn't it?
Actually, although the bill is the same, you can do much more with the money if you have it now
because over time you can earn more interest on your money.

Back to our example: By receiving $10,000 today, you are poised to increase the future value of
your money by investing and gaining interest over a period of time. For Option B, you don't have
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SY 2020-2021

time on your side, and the payment received in three years would be your future value. To
illustrate, we have provided a timeline:

If you are choosing Option A, your future value will be $10,000 plus any interest acquired over
the three years. The future value for Option B, on the other hand, would only be $10,000. So
how can you calculate exactly how much more Option A is worth, compared to Option B? Let's
take a look.

Future Value Basics

If you choose Option A and invest the total amount at a simple annual rate of 4.5%, the future
value of your investment at the end of the first year is $10,450. We arrive at this sum by
multiplying the principal amount of $10,000 by the interest rate of 4.5% and then adding the
interest gained to the principal amount:

$10,000×0.045=$450
$450+$10,000=$10,450

You can also calculate the total amount of a one-year investment with a simple manipulation of
the above equation:

OE= ($10,000×0.045) +$10,000=$10,450

where:
OE=Original equation

Manipulation=$10,000×[(1×0.045)+1]=$10,450
Final Equation=$10,000×(0.045+1)=$10,450

The manipulated equation above is simply a removal of the like-variable $10,000 (the principal
amount) by dividing the entire original equation by $10,000.

If the $10,450 left in your investment account at the end of the first year is left untouched and
you invested it at 4.5% for another year, how much would you have? To calculate this, you
would take the $10,450 and multiply it again by 1.045 (0.045 +1). At the end of two years, you
would have $10,920.25.

Calculating Future Value

The above calculation, then, is equivalent to the following equation:

Future Value=$10,000×(1+0.045)×(1+0.045)

Think back to math class and the rule of exponents, which states that the multiplication of like
terms is equivalent to adding their exponents. In the above equation, the two like terms are (1+
0.045), and the exponent on each is equal to 1. Therefore, the equation can be represented as
the following:
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SY 2020-2021

Future Value=$10,000×(1+0.045)2

We can see that the exponent is equal to the number of years for which the money is earning
interest in an investment. So, the equation for calculating the three-year future value of the
investment would look like this:

Future Value=$10,000×(1+0.045)3

However, we don't need to keep on calculating the future value after the first year, then the
second year, then the third year, and so on. You can figure it all at once, so to speak. If you
know the present amount of money you have in an investment, its rate of return, and how many
years you would like to hold that investment, you can calculate the future value (FV) of that
amount. It's done with the equation:

FV=PV×(1+i)n
where:
FV=Future value
PV=Present value (original amount of money)
i=Interest rate per period
n=Number of periods

Present Value Basics

If you received $10,000 today, its present value would, of course, be $10,000 because the
present value is what your investment gives you now if you were to spend it today. If you were
to receive $10,000 in one year, the present value of the amount would not be $10,000 because
you do not have it in your hand now, in the present.

To find the present value of the $10,000 you will receive in the future, you need to pretend that
the $10,000 is the total future value of an amount that you invested today. In other words, to find
the present value of the future $10,000, we need to find out how much we would have to invest
today in order to receive that $10,000 in one year.

To calculate the present value, or the amount that we would have to invest today, you must
subtract the (hypothetical) accumulated interest from the $10,000. To achieve this, we can
discount the future payment amount ($10,000) by the interest rate for the period. In essence, all
you are doing is rearranging the future value equation above so that you may solve for present
value (PV). The above future value equation can be rewritten as follows:

PV=FV×(1+i)−n
where:
PV=Present value (original amount of money)
FV=Future value
i=Interest rate per period
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SY 2020-2021

n=Number of periods

Calculating Present Value

Let's walk backward from the $10,000 offered in Option B. Remember, the $10,000 to be
received in three years is really the same as the future value of an investment. If we had one
year to go before getting the money, we would discount the payment back one year. Using our
present value formula (version 2), at the current two-year mark, the present value of the
$10,000 to be received in one year would be $10,000 x (1 + .045)-1 = $9569.38.

Note that if today we were at the one-year mark, the above $9,569.38 would be considered
the future value of our investment one year from now.

Continuing on, at the end of the first year we would be expecting to receive the payment of
$10,000 in two years. At an interest rate of 4.5%, the calculation for the present value of a
$10,000 payment expected in two years would be $10,000 x (1 + .045)-2 = $9157.30.

Of course, because of the rule of exponents, we don't have to calculate the future value of the
investment every year counting back from the $10,000 investment in the third year. We could
put the equation more concisely and use the $10,000 as FV. So, here is how you can calculate
today's present value of the $10,000 expected from a three-year investment earning 4.5%:

$8,762.97=$10,000×(1+.045)−3

So the present value of a future payment of $10,000 is worth $8,762.97 today if interest rates
are 4.5% per year. In other words, choosing Option B is like taking $8,762.97 now and then
investing it for three years. The equations above illustrate that Option A is better not only
because it offers you money right now but because it offers you $1,237.03 ($10,000 -
$8,762.97) more in cash! Furthermore, if you invest the $10,000 that you receive from Option A,
your choice gives you a future value that is $1,411.66 ($11,411.66 - $10,000) greater than the
future value of Option B.

Present Value of a Future Payment

Let's up the ante on our offer. What if the future payment is more than the amount you'd receive
right away? Say you could receive either $15,000 today or $18,000 in four years. The decision
is now more difficult. If you choose to receive $15,000 today and invest the entire amount, you
may actually end up with an amount of cash in four years that is less than $18,000.

How to decide? You could find the future value of $15,000, but since we are always living in the
present, let's find the present value of $18,000. This time, we'll assume interest rates are
currently 4%. Remember that the equation for present value is the following:

PV=FV×(1+i)−n

In the equation above, all we are doing is discounting the future value of an investment. Using
the numbers above, the present value of an $18,000 payment in four years would be calculated
as $18,000 x (1 + 0.04)-4 = $15,386.48.
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SY 2020-2021

From the above calculation, we now know our choice today is between opting for $15,000 or
$15,386.48. Of course, we should choose to postpone payment for four years!

Exercise

Compute the present value of each scenario

1. Your mother is expecting to get PHP. 18 000 every year at the end of the next two years after
investing in government securities that yield 6% annually.

2. Your father obtained a car loan payable in 5 equal instalments of PHP 2000 000 at the end of
the next year with an annual rate of 15%

3. Your brother borrowed from your neighbor to buy a new mobile. The neighbor charged 11%
for the borrowed amount payable in three annual payment of PHP 3 000