Financing decision思维导图
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2024-10-31
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debt finance cheaper than equity finance
debt is often secured
debt is often temporary
interest on debt finance is compulsory
debt ranks higher than equity under insolvency law
interest is tax deductible
capital structure theory
the traditional view of capital structure(图像）
At low levels of gearing
equity risk are unchanged , increase the proportion of cheaper debt will lower the WACC
At higher levels of gearing
increased financial risk;increase in Ke since risk increases ;WACC starts to rise
At very high levels of gearing
serious bankruptcy risk worries equity and WACC rises further
assumptions
No taxtion
The company pays out all its earnings as dividends
The earnings of the company are expected to remain constant in perpetuity
business risk is constant
capital employed in the business is constant
The are no transaction costs for issues
Modigliani & Miller -1958 theory with no taxation
The increase in ke exactly offests the benefit of the cheaper debt finance and the WACC remains unchanged
WACC and value of the firm are unaffected by changes in gearing levels
choice of finance is irrelevant to shareholder wealth
assumptions
No taxation
perfect captial markets
No transaction costs for issues
debt is risk free and freely available at the same cost to investors and companies
Modigliani&Miller-1963 theory with tax
context
debt interest is tax deductible so the overall cost of debt Kd to the company is lower than in M&M-no tax
The increase in Ke does not offest the benefit of the cheaper debt and therefore the WACC falls as gearing increases .
Geared companies have an advantages over ungeared companies
problems
Agency costs : restrictive covenants set by debtors-level of dividends,level of additional debt to raise,prevent firms investing
tax exhaustion : no tax to pay as interest covers all
increases in the cost of borrowing and cost of equity as gearing increases (direct financial distress costs .
Bankkruptcy risk from loss of sales/higher costs from suppliers
real world issues to gearing
static trade-off theory
firms maintain the level of gearing in a stable position which is set based on its specific business context
pecking-order theory
1.retained earnings
disadvantages
not enough cash flows
retained earnings should be used to pay dividends
advantages
do not have to spend any time persuading outside investorsn
no issue costs
2.debt
some degree of questioning and publicity
moderate issue costs
3.New issue of equity
extensive questioning and pubilcity
expensive issue costs
sign of a lack of confidence by directors that share price is overvalued .
A compromise approach
select a long run target gearing ratio
whilst far from target , decision should be govered by static trade-off theory
when close to target, pecking order theory will dictate source of funds .
gearing drift
their gearing level gredually reduces over times as accumulated profis help to increases the value of equity
revise mothed : issue debt , or paying a large dividend or buying back shares
signaling to investors
public issue of shares
advantages
eliminate the debt in the company
gain higher reputation
owners may sell or buy equity
easier to raise finance from a large number of investors
disadvantages
expensive and time-consuming
higher regulation and scrutiny
the threat of takeover increases
stock exchange listing requirement
Track record requirements , market capitalization ,share in public hands ,future prospects , audited historical financial information,corporate governance , acceptable accounting standards
delisting
removal of a listed security
not meet the listing requirements
Factors determine the level of gearing
directors preferences
concerned about too high a burden if payment to finance providers
a change in the shareholder base as a result of a share issue may impact upon their own position
the impression given by their choice of finance
cost and cash flows
more debt can get lower cost and tax relief
more debt also increased finance cost and rise cost of equity
interest payment is compulsory but dividends do not have to be paid
availability
equity issue time to arrange and require shareholder approval and has a significant debt the lenders will not borrowing
timescale over which finance is available may be significant .
mix
concerned about the gearing far from industry average
keeping debt as a significant element in overall finance may act as a deterrent to acquirers becoming interested in making a bid for us
directors may also not have a target figure
alternative methods of obtaininig a stock market listing
IPO
direct listing
without getting help from intermediaries . No support or guarantee for the share sales and no promotion of it
Dutch auctions (descending price auction)
advantages
institutional and smaller investors can be involved
more transparency
disadvantages
final price might not accurately reflect the company's prospects
special purpose acquisition companies(SPACs)
purpose of acquiring or merging
Dark pool trading systems
the trades are facilitated away from the central exchanges
a large block order on the open market , because of market forces is might prompt a changes in the price
problems
reduces the market efficiency
transparency is reduced
Mezzanine Debt
often these debt is unsecured . the risk and return is bigger than preference shares and smaller than ordinatry shares
suitable for small , high growth firms with high risk of default
crytocurrency
A cryptocurrency is a digital or virtual currency that uses cryptography for security . Based on the blockchain ledger
classification
initial coin offering (ICO)
It is securitied by new technology created by the project or accesss to services
no government regulation
Security token offering (STO)
It is securitied by real monetary value in the real world
higher government regulation
Islamic Finance
base principles
require fairness , no misleading or cheating
interest is forbidden in islamic finance
classification
Murabaha(trade credit/loan)
Ijara (lease finance)
Sukuk (islamic bonds)
mudaraba (equity finance )
Musharaka (venture captial)
Salam (forward contracts)
Istisna (long-term, large construction )
Green finance
investments in environmental goods and services
schemes that encourage sustainability
financeing foreign projects
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