FIN 420

PPT 09

LOGO March 2015

CHAPTER 9

LONG TERM FINANCING

Prepared By:

Dr. Norliza Che Yahya

Center for Economics and Finance Studies
Faculty of Business and Management
Universiti Teknologi MARA (UiTM),
42300 Puncak Alam Campus,
Office: PFI 04 -032 Office (tel): 03-3258 7077
Email: norliza9911@puncakalam.uitm.edu.my or norlizacheyahya@yahoo.com
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 SYLLABUS CONTENT
CODE CHAPTER
Ppt 01 Introduction to Financial Management
Ppt 02 Understanding Financial Statements
Ppt 03 Financial Ratios and Analysis
Ppt 04 Financial Forecasting and Planning
Ppt 05 Working Capital Management
Ppt 06 Cash and Marketable Securities Management
Ppt 07 Accounts Receivable & Inventory Management
Ppt 08 Short Term Financing
Ppt 09 Long Term Financing
Ppt 10 Mathematics of Finance
Ppt 11 Capital Budgeting

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 CHAPTER OUTLINE

NO. CONTENT
1. Types of Long Term Financing
2. Characteristics of Financing Types
3. Advantages and Disadvantages of Financing Types
4. Cost of Financing

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 WHERE ARE WE?

Balance Sheet
Current Assets Current Liabilities

Financing Decision
Investment Decision

 Cash  A/c Payable

 Marketable Sec.  Short term Loan
 A/c Receivables
 Inventory Long Term Liabilities
 Bond
Fixed Assets
 Land
 Machinery Equity
 Common Stock
 Preferred Stock

Total Assets = Total Liabilities +

Equity

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 LONG TERM FINANCING

What is Long Term Financing?

 Is a long-term obligation or financing that is expected to mature in more

than one year (i.e., repayment period is > 1 year).
 Financial manager needs long-term sources of financing to fund
purchase of long term assets.

What is Cost of Capital?

 For Investors - rate of return on a security is a benefit of investing.

 For Financial Managers - rate of return is a cost of raising funds that are
needed to operate the firm.
 In other words, cost of raising funds = firm’s cost of capital.

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 Types of Long Term Financing

COMMON
BOND STOCKS

How can a
firm raise
PREFERRED
funds? STOCKS

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 Bond

Definitions & Concept Characteristics

 A promissory note issued by firms
indicating that a firm has borrowed  Coupon rate : interest rate that
certain amount of money and
promised to pay interest on certain
date and principal on maturity date.
 2 parties involved that are the bond
issuer (the borrower) and bond
holder (the lender).
 Indenture is agreement between bond
issuer and bondholder to specify any
terms and conditions of the bond
contract.
 Par value : RM1,000.
bondholders will get annually, usually
it is expressed in terms of a
percentage of par value.
 Maturity : time when the issuer
returns the principal.
 Call provision : it is one of the terms
to be included in the indenture which
states that the issuer has the right to
repurchase or call the bonds before
maturity at a stated prices.
 Claims on assets and income of the
company in case of bankruptcy: the
first to claim.

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 Common Stocks

Definitions and Concept Characteristics

 A certificate that represents an  No specific amount of par value.
evidence of ownership of the firm.  Dividend: it is at the discretion of
the BOD to decide on the
 When you buy a share, you buy a dividend amount to be paid to
“part/share” of the company and shareholders.
attain ownership rights in  Maturity : no maturity period.
proportion to your “share” of the  Voting rights: the rights to elect
company. the BOD.
 Preemptive rights: the rights given
 Common stockholders are the true to the existing shareholders to
owners of the firm. Bondholders buy additional new shares.
and preferred stock holders can  Claims on assets and income of
be viewed as creditors. the company in case of
bankruptcy: the last to claim.

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 Preferred Stocks

Definitions and Concept Characteristics

 Legally an equity security.  Par value : RM100.

 It is a hybrid type of security  Fixed amount of dividend.

where it has both the
characteristics of bond and  Maturity : no maturity period.
common stocks.
 Claims on assets and income of
 Preferred means priority of the company in case of
claims on income and assets of bankruptcy: second to claim
the company

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 ADVANTAGES AND DISADVANTAGES OF FINANCING TYPES

Bond
Advantages Disadvantages
1. FOR INVESTORS Limited Income
Seniority in Claims: Regardless as how profitable the company
Honored in the case of insolvency. is or may become, bondholders receive
only a fixed, limited income.
Low Risk:
Receive fixed stream of cash flows.
Voting Rights:
Bondholders are not entitled to vote for
2. FOR ISSUER (COMPANY) directors.
Control
A company do not have to share ownership.
Inflexibility:
Cost of funds provisions on a long-term bond are much
Interest paid to the bondholders are tax more stringent than they are in common
deductible, thus a cheaper source of capital. and preferred stock.

Taxes
Interest paid is exempted from tax.

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 ADVANTAGES AND DISADVANTAGES OF FINANCING TYPES

Common Stocks
Advantages
Rights to votes and assets:
Common stockholders are entitled to
vote for directors.
Ownership of company:
Portion of ownership in the company
will be according to the number of
shares held.
Disadvantages
Seniority:
In the event of bankruptcy, common
stockholders will not receive any payment
until all the creditors, including the
bondholders and preferred stockholders,
have been satisfied.

Liability:
Limited to amount of investment.

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 ADVANTAGES AND DISADVANTAGES OF FINANCING TYPES

Preferred Stocks
Advantages Disadvantages
Claim on Assets: Limited Income:
Preferred stock has priority over Regardless as how profitable the company
common stock with regard to claim on is or may become, preferred shareholders
assets in the case of bankruptcy. receive only a fixed, limited income.

Claim on Income: Voting Rights:

Preferred stock also has priority over Preferred stockholders are not entitled to
common stock with regard to dividend vote for directors.
payments.

Thus preferred stocks are safer than

common stock but riskier than bonds.

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COST OF LONG TERM FINANCING (or COST OF CAPITAL)

Cost of Bond
BEFORE TAXES COST OF BOND

Where
 C is the coupon or interest payment = % coupon rate x bond par value
 PV is the par value of bond = RM1,000
 MP is the Net Proceeds from the sale of bond = selling price – floatation cost.
 FC is floatation cost = % FC x selling price (or par value)
 N = Maturity period

AFTER TAXES COST OF BOND

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COST OF LONG TERM FINANCING (or COST OF CAPITAL)

Cost of Common Stocks

RETAINED EARNINGS

NEW ISSUE OF COMMON STOCKS (main formula for CS)

Where
 D1 is the expected dividend = D1 = D0 (1 + g)
 MP is the market price
 NP is the Net Proceeds from the sale of stock = selling price – floatation cost
 g is the growth rate

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COST OF LONG TERM FINANCING (or COST OF CAPITAL)

Cost of Preferred Stocks

Where

 D is the dividend payment = % dividend rate x preferred stock par value

 CP is the Net Proceeds from the sale of the stock = Market selling price
– floatation cost

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 Past Semester Questions

 January 2018, Question 4 (a)

 June 2014, Question 5 (a)

 December 2016, Question 4 (a)

 June 2015, Question 6 (b)

 January 2013, Question 4 (a)

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LOGO

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