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Fundamentals of Corporate

Finance

Sixth Edition

Richard A. Brealey

Stewart C. Myers

Alan J. Marcus

Slides by

Matthew Will

Chapter 14

McGraw Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved

Introduction to Corporate Financing

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Topics Covered

Creating Value with Financing Decisions Common Stock Preferred Stock Corporate Debt Convertible Securities Patterns of Corporate Financing

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Types of Securities Equity

Common stock Preferred stock

Debt Commercial paper Debentures Guaranteed notes Remarketable debt Euro notes Sterling notes New Zealand dollar notes Bank loans

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Common Stock

Treasury Stock

Stock that has been repurchased by the company and held in its treasury

Issued Shares

Shares that have been issued by the company.

Outstanding Shares

Shares that have been issued by the company and held by investors.

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Common StockAuthorized Share Capital

Maximum number of shares that the company is permitted to issue, as specified in the firm’s

articles of incorporation.

Par Value

Value of security shown on certificate.

Retained Earnings

Earnings not paid out as dividends.

Addiotional Paid Up CapitalDifference between issue price and par

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Common Stock

Book Value vs. Market ValueBook value is a backward looking measure. It tells us how much capital the firm has raised from shareholders in the past. It does not measure the value that shareholders place on those shares today. The market value of the firm is forward looking, it depends on the future dividends that shareholders expect to receive.

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Common Stock

Example - H.J. Heinz Book Value vs. Market Value (5/2007)

Total Shares outstanding = 322 million

1,843Value)(Book equity common Net

219-Other

4,406-costat sharesTreasury

5,779earnings Retained

581capitalin paid Additional

108par) ($.25 SharesCommon

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Common Stock

Example - H.J. Heinz Book Value vs. Market Value (5/2007)

Total Shares outstanding = 322 million

billion $14.812ValueMarket

322x shares of #

$46/sh= priceMarket 2007May

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Common Stock

Corporate Equity Holdings

Mutual Funds28.3%

Pension Funds22.3%

Insurance Companies

8.0%

Rest of World12.6%

Households27.1%

Other1.4%

Banks & Savings0.3%

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Preferred Stock

Preferred Stock - Stock that takes priority over common stock in regards to dividends.

Net Worth - Book value of common shareholder’s equity plus preferred stock.

Floating-Rate Preferred - Preferred stock paying dividends that vary with short term interest rates.

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Corporate Debt

Debt has the unique feature of allowing the borrowers to walk away from their obligation to pay, in exchange for the assets of the company.

“Default Risk” is the term used to describe the likelihood that a firm will walk away from its obligation, either voluntarily or involuntarily.

“Bond Ratings”are issued on debt instruments to help investors assess the default risk of a firm.

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Corporate Debt

Prime Rate - Benchmark interest rate charged by banks.

Funded Debt - Debt with more than 1 year remaining to maturity.

Sinking Fund - Fund established to retire debt before maturity.

Callable Bond - Bond that may be repurchased by firm before maturity at specified call price.

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Corporate Debt

Subordinate Debt - Debt that may be repaid in bankruptcy only after senior debt is repaid.

Secured Debt - Debt that has first claim on specified collateral in the event of default.

Investment Grade - Bonds rated Baa or above by Moody’s or BBB or above by S&P.

Junk Bond - Bond with a rating below Baa or BBB.

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Corporate Debt

Eurodollars - Dollars held on deposit in a bank outside the United States.

Eurobond - Bond that is marketed internationally.

Private Placement - Sale of securities to a limited number of investors without a public offering.

Protective Covenants - Restriction on a firm to protect bondholders.

Lease - Long-term rental agreement.

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Convertible Securities

Warrant - Right to buy shares from a company at a stipulated price before a set date.

Convertible Bond - Bond that the holder may exchange for a specified amount of another security.

Convertibles are a combined security, consisting of both a bond and a call option.

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Patterns of Corporate Financing

Firms may raise funds from external sources or plowback profits rather than distribute them to shareholders.

Should a firm elect external financing, they may choose between debt or equity sources.

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Patterns of Corporate Financing

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0

50

100

150

200

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

Year

Per

cent

of

tota

l sou

rces

New Debt

New Equity

Internal Funds

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Patterns of Corporate FinancingD

ebt R

atio

, %Debt to (Debt + Equity) Ratio for Non-Financial Firms

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Web Resources