Revenues and costs are those that have occurred. The market value of equity relates to the future. It is the best estimate by the market of the future prospects of the firm. Change in Net Working Capital 20XX Ending net working capital [ — ] — beginning net working capital [ — ].
In the first year, equity is not given. Therefore, we must calculate equity as a plug variable. To calculate the cash flow from assets, we need to find the capital spending and change in net working capital. The capital spending for the year was:. The expansion plans may be a little risky.
The company does have a positive cash flow, but a large portion of the operating cash flow is already going to capital spending. The company has had to raise capital from creditors and equity holders for its current operations.
So, the expansion plans may be too aggressive at this time. On the other hand, companies do need capital to grow. Before investing in the company or lending it money, you would want to know where the current capital spending is going, and why the company is spending so much in this area already. Millions discover their favorite reads on issuu every month. Click here to sign up. Download Free PDF. Tong Man. A short summary of this paper.
Download Download PDF. Translate PDF. The indenture is a legal contract and can run into pages or more. Bond features which would be included are: the basic terms of the bond, the total amount of the bonds issued, description of the property used as security, repayment arrangements, call provisions, convertibility provisions, and details of protective covenants.
The differences between preferred stock and debt are: a. The dividends on preferred stock cannot be deducted as interest expense when determining taxable corporate income.
In case of liquidation at bankruptcy , preferred stock is junior to debt and senior to common stock. There is no legal obligation for firms to pay out preferred dividends as opposed to the obligated payment of interest on bonds. Therefore, firms cannot be forced into default if a preferred stock dividend is not paid in a given year. Preferred dividends can be cumulative or non-cumulative, and they can also be deferred indefinitely of course, indefinitely deferring the dividends might have an undesirable effect on the market value of the stock.
Some firms can benefit from issuing preferred stock. The reasons can be: a. Public utilities can pass the tax disadvantage of issuing preferred stock on to their customers, so there is a substantial amount of straight preferred stock issued by utilities. They may be willing to issue preferred stock. Firms that issue preferred stock can avoid the threat of bankruptcy that exists with debt financing because preferred dividends are not a legal obligation like interest payments on corporate debt.
The return on non-convertible preferred stock is lower than the return on corporate bonds for two reasons: 1 Corporate investors receive 70 percent tax deductibility on dividends if they hold the stock. Therefore, they are willing to pay more for the stock; that lowers its return. Preferred dividends are paid out of net income, hence they provide no tax shield. Corporate investors are the primary holders of preferred stock since, unlike individual investors, they can deduct 70 percent of the dividend when computing their tax liabilities.
Therefore, they are willing to accept the lower return that the stock generates. The following table summarizes the main difference between debt and equity: Debt Equity Repayment is an obligation of the firm Yes No Grants ownership of the firm No Yes Provides a tax shield Yes No Liquidation will result if not paid Yes No Companies often issue hybrid securities because of the potential tax shield and the bankruptcy advantage.
If the IRS accepts the security as debt, the firm can use it as a tax shield. If the security maintains the bankruptcy and ownership advantages of equity, the firm has the best of both worlds. There are two benefits. First, the company can take advantage of interest rate declines by calling in an issue and replacing it with a lower coupon issue.
Second, a company might wish to eliminate a covenant for some reason. Calling the issue does this. The cost to the company is a higher coupon. The cost to the company is that it may have to buy back the bond at an unattractive price. It is the grant of authority by a shareholder to someone else to vote his or her shares.
Preferred stock is similar to both debt and common equity. Preferred shareholders receive a stated dividend only, and if the corporation is liquidated, preferred stockholders get a stated value. However, unpaid preferred dividends are not debts of a company and preferred dividends are not a tax deductible business expense. A company has to issue more debt to replace the old debt that comes due if the company wants to maintain its capital structure.
There is also the possibility that the market value of a company continues to increase we hope. This also means that to maintain a specific capital structure on a market value basis the company has to issue new debt, since the market value of existing debt generally does not increase as the value of the company increases at least by not as much. Internal financing comes from internally generated cash flows and does not require issuing securities.
In contrast, external financing requires the firm to issue new securities. The three basic factors that affect the decision to issue external equity are: 1 The general economic environment, specifically, business cycles. When a company has dual class stock, the difference in the share classes are the voting rights. Dual share classes allow minority shareholders to retain control of the company even though they do not own a majority of the total shares outstanding.
Often, dual share companies were started by a family, and then taken public, but the founders want to retain control of the company. The statement is true. In an efficient market, the callable bonds will be sold at a lower price than that of the non-callable bonds, other things being equal. This is because the holder of callable bonds effectively sold a call option to the bond issuer. As the interest rate falls, the call option on the callable bonds is more likely to be exercised by the bond issuer.
Since the non-callable bonds do not have such a drawback, the value of the bond will go up to reflect the decrease in the market rate of interest.
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