Slide strategic financial management l09

Strategic
Strategic Financial
Financial Management
Management
OVERVIEW OF THE FINANCING DECISION

Khuram Raza
ACMA, Ms Finance


First Principle and Big Picture


The Choices: Types of Financing
There are only two ways in which any business can raise

money

 Debt or Equity.
This may seem simplistic, given the array of choices firms have in terms of financing vehicles.
We will begin this section with a discussion of the

 characteristics of debt and equity
 and then look at a range of financing vehicles available within each of these categories.
 We will then examine of a range of securities that share some characteristics with debt and
some with equity and are therefore called hybrid securities.


The Continuum between Debt and Equity

Debt is defined as any financing vehicle that is a contractual claim on the firm (and not a

function of its operating performance), creates tax-deductible payments, has a fixed life,
and has a priority claim on cash flows in both operating periods and in bankruptcy.

Equity is defined as any financing vehicle that is a residual claim on the firm, does not

create a tax advantage from its payments, has an infinite life, does not have priority in
bankruptcy, and provides management control to the owner.


The Continuum between Debt and Equity

Fixed Claim

Residual Claim

Tax Deductible

Not Tax Deductible

High Priority in Financial Trouble

Lowest Priority in Financial Trouble

Fixed Maturity

Infinite

No Management Control

Management Control

Debt

Equity


Debt and Equity

Fixed Claim

Residual Claim

Tax Deductible

Not Tax Deductible

High Priority in Financial Trouble

Lowest Priority in Financial Trouble

Fixed Maturity

Infinite

No Management Control

Management Control

Debt

Equity

Bank Debt

Owner’s Equity

Corporate Bonds

Venture Capital
Hybrid Securities

Leases

Stock
ConvertibleCommon
Debt
Preferred Stock
Options/Warrants
Option-linked Bonds


Financing Choices and a Firm’s Life Cycle


Revenue/ Earnings

Financing Choices and a Firm’s Life Cycle

Time

Start-up

Rapid Expansion

High Growth

Owner’s Equity

Venture Capital

Common stock

Bank Debt

Common Stock

Warrants
Convertibles

Mature Growth

Debt /Bonds

Decline

Retire debt
Repurchase stock

The Process of Raising Capital
Private Firm Expansion: Raising Funds from Private Equity

Provoke equity investor’s interest
Valuation and Return Assessment
Structuring the Deal
Post-deal Management
Exit


The Process of Raising Capital
From Private to Publicly Traded Firm: The Initial Public Offering

 Staying Private versus Going Public



access to financial markets



loss of control

Overall, the net tradeoff to going public will generally be positive for firms with large growth opportunities and
 market
 disclosure
and legal requirements
funding
needs.value
It will be smaller for firms that have smaller growth

opportunities,
substantial internal cash flows, and
owners who value the complete control they have over the firm


Investment Sector

Traditional Underwriting
Value of Rights
Investment Banker

Privileged Subscription

Terms of Offering

Preemptive Right

Saving Sector

Private Placement
Best Efforts Offering


Value of Rights

What gives a right its value?
A right allows you to buy new stock at a discount that typically ranges between 10 to 20 percent
from the current market price.
The market value of a right is a function of :

•
•
•

the market price of the stock
the subscription price

R0 =

the number of rights required to purchase an additional share of stock

P0 – S
N+1


Example of the Valuation of a Right
What is the value of a right when the stock is selling “rights-on”? What is the
value of one share of stock when it goes “ex-rights”?

•

Assume the following information:

•

The current market price of a
stock “rights-on” is $50.

•
•

The subscription price is $40.
It takes nine rights to buy an additional share of stock.


How is the Value of a Right Determined?

Solving for R0.

R0 =

$50 – $40
9+1

R0 = $1

Solving for PX.

PX =

PX = $49

($50 )(9) + $40
9+1


Stock Market Efficiency


Stock Market Efficiency

Stock Market Efficiency


Stock Market Efficiency