Chapter 6:

FINANCING ANY
ENTETERPRISE
GROUP 2:

Micah C. Cabbab, Alyssa Pearl Ruma, Arianne Mendoza, Marie Miguel, Jae Antonette Baquiran, Marilou Esteban
I. Methods of Financing
o Equity Financing
o Capital is coming from either retained earnings or funds raised
from an issuance of stock.
o Debt Financing
o Money raised through loans or by an issuance of bonds.
o Capital Structure
o Well managed firms establish a target capital structure and strive
to maintain the debt ratio.
 Equity Financing

• Flotation (discount) costs

• The expenses associated with Retained earnings
issuing new securities

• Types of equity financing Preferred stock

o Retained earnings
Common stock
o Common stock
o Preferred stock
 Debt Financing
• Bond Financing:
o May incur floatation cost
o No partial payment of principal
o Only interest is paid each year (or
semi-annually).
Bond
o The principal (face value) is paid
in a lump sum when the bond
matures.
• Term Loan:
Term Loan
o May involve an equal repayment arrangement
o May incur origination fee
o Terms negotiated directly between the
borrowing company and a financial institution
 Capital Structure (Debt Ratio)
• Definition: The means by which a firm is financed.
• Mixed Financing: Capital is raised by borrowing from financial
institutions and by issuing stocks and/or using retained earnings.
• Target Capital Structure: Set a target debt ratio by considering both
business risk and expected future earnings.
II. Working Capital
III. Types of business organizations
a. Sole Proprietorship
b. Partnership
c. The corporation
IV. Dangers of the Corporation Form of Business
Organization

• There is a greater degree of government control and supervision.

It requires a relatively high cost of formation and operation. It is
subject to heavier taxation than other forms of business
organizations. Minority shareholders are subservient to the
wishes of the majority.
IV. Dangers of the Corporation Form of Business
Organization

• DISHONESTY OF THE PROMOTERS. Persons who have

taken initiative in forming corporations where there only interest
is the promotion fees which they can collect after the formation
of the corporation and not in the enterprise itself.
IV. Dangers of the Corporation Form of Business
Organization

• DISHONESTY OF THE MANAGEMENT. The officers of the

corporation may be dishonest and their only aim may be to
enrich themselves at the expense of the stockholders by paying
themselves unreasonably large salaries, and by employing their
relatives and paying them salaries far in excess of their
capabilities or the value of their job.
IV. Dangers of the Corporation Form of Business
Organization

• WATERING OF STOCK. The stocks of a corporation are said to

be watered if the amount of stocks issued is far in excess of the
actual value of the assets of the corporation. The watered stocks
which do not represent any assets often go to the dishonest
officer of the corporation, earn the same dividends as the other
stocks to the detriment of the stockholders.
IV. Dangers of the Corporation Form of Business
Organization

• ABSENTEE OWNERSHIP. Most of the stockholders may know

nothing of the affairs of the business because they are not
employed in the enterprise. Usually they get satisfied if they get
a large amount of annual dividend, not knowing that these
dividends may have been obtained through the payment of low
wages to its workers or by some means.
V. Capitalization of a corporation
VI. Common stock vs. Preferred stock
• Common stock is a share of ownership in a company. It typically gives its owner
the right to vote on the company's leadership — the board of directors.
Depending on the company, common stock may also entitle its owner to a share
of the company's profits, in the form of dividends.
• Preferred stock is a type of stock that pays shareholders a specified dividend and
has priority over common stock for receiving dividends. Preferred stock may be
a better investment for short-term investors who can’t hold common stock long
enough to overcome dips in the share price. This is because preferred stock tends
to fluctuate a lot less, though it also has less potential for long-term growth than
common stock.
VII. Bonds
• By Definition, “A Bond is a fixed income instrument that represents a loan made by an
investor to a borrower.” In simpler words, bond acts as a contract between the investor
and the borrower. Mostly companies and government issue bonds and investors buy those
bonds as a savings and security option.
• These bonds have a maturity date and when once that is attained, the issuing company
needs to pay back the amount to the investor along with a part of the profit. This kind of
dealing with bonds between the issuer and the investor is done by brokers.
VIII. Classification of bonds
According to the method of paying interest, bonds are classified into:
• REGISTERED BONDS. The owner’s name is recorded in the books of the corporation,
and interest is paid periodically to the owners without asking for it.
• COUPON BONDS. These are bonds to which are attached coupons indicating the
interest due and the date when it is to be paid. The owner can collect the interest due by
surrendering the same to the officers of the corporations or cashing it at specified banks.
VIII. Classification of bonds
According to the security behind the bonds, bonds are classified into:
• MORTGAGE BONDS. These are the bonds whose security is a mortgage in certain
assets of the corporation. If the corporation fails to pay the bond value on the date of
maturity, title of the property is transferred to the bondholders, who may take possession
and sell the same to reimburse their investment.
• COLLATERAL TRUST BONDS. The corporation pledges securities which it owns,
such as the stocks or bonds of one of its subsidiaries.
VIII. Classification of bonds
According to the security behind the bonds, bonds are classified into:
• EQUIPMENT OBLIGATIONS BONDS. These are the bonds whose guaranty is a line
on railroad equipment, such as freight and passenger cars, locomotives, and other railroad
equipment.
• DEBENTURE TRUST BONDS. These are bonds without any security behind except a
promise to pay by the issuing corporation.
• JOINT BONDS. Sometimes, two or more corporations issue bonds which are guaranteed
jointly and severally by them. Each of the issuing corporations is liable for the entire
bond issue in case of default.
IX. Bond amortization and retirement
X. Value of a bond
• Value of a Bond
It is defined to be the present worth of all the amounts the bondholder
will receive through his possession of the bond.
• The bondholder will receive two types of payments which are:
• 1. Single payment which the owner will receive at the date of maturity of
the bond, which is usually equal to the par value of the bond; and
2. The periodic payments for interest on the bond usually it is redeemed
by the issuing corporations.
Formula for value of a bond:

Where
Vn = value of the bond n periods before redemption
F = par value of the bond
C = amount paid to the bondholder at maturity of the bond which is usually equal to F
n = number of periods prior to redemption
r = rate of interest on the bond per period
i = actual rate of interest on the amount invested in the bond usually called yield.
Derivation of the Formula for Value of a Bond