Long Term Financing
Long Term Financing
Long Term Financing
✔ Debt/bond
⚫ Preferred stock
⚫ Common equity – common stock and
retained earnings
Debt
The use of debt will result in a fixed
obligation that needs servicing regardless
of the financial conditions of the firm.
Term
Bond
Loans
Long-ter
m Debt
Term Loans
Can be obtained in a short time, flexible and
low issuance costs with maturity of more than
5 years.
Sources: banks, insurance company, or
pension fund.
May have fixed or variable interest rates.
Bond
A long-term promissory note issued by a
government or business unit that obligates
the issue to make periodic interest payments
and the principal payment at maturity date to
the holder.
Bond Characteristics/
Features
Coupon Yield to
Par Value
Interest Rate Maturity
Bond
Call Provision Bond Ratings
Maturities
Bond Characteristics/
Features
Par Value Call Provision
◦ The stated face value of the ◦ Gives the issuing firm the
bond, usually RM1,000. right to call-in the bond
Coupon Interest Rate before maturity.
◦ Percentage of par value of the
bond that will paid out
Bond Ratings
periodically to the bondholders ◦ Serve as a qualitative guide
in the form of interest to the probability of default.
payments.
Bond Maturities
◦ Interest payment can be paid
annually or semi annually. ◦ The date on which the par
value of the bond is to be
Yield to Maturity (YTM)
repaid to the bondholders.
◦ The rate the bondholder would
earn if they bought the bond, ◦ Maturities generally vary
held it until maturity and from five to forty years.
reinvested the interest earned.
Bond Categories
Bond Categories
Secured Unsecured
Bonds Issued
Convertible with Stock Indexed Zero Coupon Subordinates
Debentures Income Bonds
Bonds Purchase Bonds Bonds Debenture
Warrants
Bonds
Convertible Bonds Debentures
◦ Bonds that may be exchanged for ◦ Long-term claims issued by
shares of common stock. credit worthy companies that is
Bonds issued with Stock Purchase not secured by any specific
Warrants assets of the company.
◦ Similar to convertible bonds; allows Subordinated Debenture
the holder to buy the stock at ◦ Also known as junior debt;
some agreed upon fixed prices.
entitles the bondholder to get
Indexed Bonds settlement after all senior
◦ Bonds that have interest rates creditors are paid in case of
pegged to some price index. liquidation.
Zero Coupon Bonds Income Bonds
◦ Bonds sold at deep-discount below ◦ Pay interest only when the firm
par value. earns enough profits to pay
◦ There are no cash outlays for interest.
interest or principal payments until
maturity.
Where:
CP Coupon payment
M Maturity Value
k Discount rate or rate of return
n Period to maturity
Illustration
Kb = Annual Interest
Par Value
Solution:
Kb = Annual Interest
Par Value
= 100 / 1000
= 0.1
Kb (after tax) = kb (1 - tax rate)
= 0.1 (1-0.35)
= 6.5%
Calculation on cost of debt if it sold below
or above par value
on cost of debt if it sold below or above par
If there is a flotation cost (i.e broker’s
value fees, commission fees, legal fees and
underwriting fees)
Solution:
Kb = 110 + (1000 – 900)
20 a
1000 + 900
2
= 12.11%
= 7.27%
Example 3
Lets assume that TM Afic Inc. plans to issue
bonds that have a face value of RM1,000 and
an annual coupon interest of 12% for 10
years. Due to high interest rates, it can be
sold for RM950 each with issuance cost of 5%.
Assume the tax rate is 40%.
Workings
Cost of Debt before Tax, Kb = 120 + 1,000 – (950 – 50)
( )
10
1,000 + (950 – 50)
2
= 13.68%
Where:
DPS Preferred Shares Dividend
P0 Selling Price of Preferred Shares
FC Floatation Cost
Example 4
TM Afiq plans to issue RM1,000,000 of RM100 par preferred stock
that pays 10% dividend. The market price of the issues is RM98
with 5% floatation cost. Calculate:
a) after-tax cost of the preferred issues.
b) selling price of preferred stock.
Using SML:
Using DGM:
Exercise
Kps = 6.42
80
= 8.03%
D1 = D0 (1+g)
= 6 (1+0.07)
c. Common stock for RM90 flotation cost of 8%
=6.42
FC = 8% x 90 = 7.2, D1 = 6.42, g = 7%
Kcs = 6.42 + 7%
90 – 7.2
= 14.75% Kcs = (D1 / P0 – FC) + g
END OF
CHAPTER 9
TQ…☺