Athens University of Economics and Business

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1 Athens University of Economics and Business MSc in International Shipping, Finance and Management Corporate Finance George Leledakis

2 An Overview of Corporate Financing

3 Topics Covered Corporate Structure Role of the Financial Manager Patterns of Corporate Financing Common Stock Debt Financial Markets and Institutions Factoring

4 Corporate Structure Sole Proprietorships Partnerships Unlimited Liability Personal tax on profits Limited Liability Corporations Corporate tax on profits + Personal tax on dividends

5 Role of the Financial Manager (2) (1) Firm's operations Financial manager (4a) Financial markets (3) (4b) (1) Cash raised from investors (2) Cash invested in firm (3) Cash generated by operations (4a) Cash reinvested (4b) Cash returned to investors

6 Role of the Financial Manager Real assets Financial assets / Securities Capital markets and financial markets Investment / capital budgeting Financing / capital structure Payout policy / dividend or share buy back

7 Patterns of Corporate Financing How Firms Raise Funds Plowing back profits Seeking external financing Debt sources Equity sources

8 Patterns of Corporate Financing Internal funds Net equity issues Net borrowing 100% 50% 0% -50% -100%

9 Modern Types of Financing Factoring Venture Capital Convertible Bonds Leasing M&A Securitization

10 Patterns of Corporate Financing Aggregate balance sheet for manufacturing corporations in the United States, 2003 (figures in Billions). Current assets $ 1,530 Current liabilities $ 1,213 Fixed assets 2,410 Long term debt 1,050 Less 1,272 Other long term 761 deprecication liabilities Net fixed assets 1,138 Total long term liabilities 1,811 Other long term 2,310 Stockholders' equity 1,964 Total assets 4,978 Total liabilities and 4,978 stockholders' equity

11 Patterns of Corporate Financing How do we define debt? Debt Total assets 1,213 1,811 4, Long termliabilitie s Long termliabilitie s equity 1,811 1,811 1,964.48

12 Debt Ratio, % Debt Ratios (D/E) Debt to Net Worth for Non-Financial Firms, % Market Debt Ratio Book Debt Ratio 50% 40% 30% 20% 10% 0% Source: Board of Governors of the Federal Reserve System, Flow of Funds Table B.102

13 Sweden Germany Austria France USA Belgium Japan Denmark Portugal Spain Finland Netherlands Debt ratio. percent Patterns of Corporate Financing (Debt to total assets)

14 Common Stock Book Value vs. Market Value Book 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.

15 Holdings of Corp Equities (2008) Rest of World 11.7 Other 1.9 Households 35.7 Mutual Funds, etc Insurance Companies 7.5 Pension Funds 19.2 Percent of Holdings

16 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.

17 Issues with Common Stock Who owns the corporation? Voting procedures Majority voting Cumulative voting Dual class shares and private benefits the same cash-flow rights /different control rights REITs (Real Estate Investment Trusts) REITs were created to facilitate public investment in commercial real estate

18 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.

19 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.

20 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.

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

22 Holdings of Corp Debt (2008) Other 26.4 Banks 4.5 Households 10.9 Pension Funds 6.5 Insurance Companies 19.9 Rest of World 21.3 Percent of Holdings Mutual Funds, etc. 10.5

23 Financial Manager Questions 1. Should the company borrow short term or long term? 2. Should the debt be fixed or floating? 3. Should you borrow dollars or some other currency? 4. What promises should you make to the lender? 5. Should you issue straight or convertible bonds?

24 Financial Markets Money Primary Markets Secondary Markets OTC Markets

25 Flow of Savings to Investment

26 Financial Markets and Institutions Financial Markets Used to raise money through primary issues Allow investors to trade amongst themselves Help firms manage risks Financial Intermediaries Raise money from investors, provide financing Banks, insurance companies, investment funds

27 Financial Assets of U.S. Intermediaries third quarter, 2011

28 Financial Markets and Institutions Investment Funds Mutual Fund Raises money by selling shares to investors Attempts to beat market Money Market Fund Invests in short-term safe securities Closed-End Fund Fixed number of shares

29 Financial Markets and Institutions Investment Funds Exchange-Traded Fund (ETF) Portfolio bought or sold in single trade Hedge Fund Restricted access Limited partnership Performance-related fees

30 Financial Markets and Institutions Financial Institutions Commercial banks Provide loans, safe money storage Investment banks Assist companies in raising financing Advise on takeovers, mergers, and acquisitions Insurance companies Invest in corporate stocks and bonds

31 The role of financial markets and intermediaries Payment Mechanism Allows individuals to make and receive payments quickly and safely over long distances Borrowing and Lending Channels savings towards those who can best use them

32 The role of financial markets and intermediaries Pooling Risk Allows individuals to share risk, i.e., insurance companies Information Allows estimation of expected rates of return

33 Factoring

34 What is Factoring? Factoring is a transaction in which a business sells its accounts receivable, or invoices, to a third party commercial financial company, also known as a factor. This is done so that the business can receive cash more quickly than it would by waiting 30 to 60 days for a customer payment. Factoring is sometimes called accounts receivable financing.

35 Factoring The terms and nature of factoring can differ among various industries and financial services providers. Most factoring companies will purchase your invoices and advance you money within 24 hours. The advance rate can range from 80% to as much as 95% depending on the industry, your customers credit histories and other criteria. The factor also provides you back-office support. Once it collects from your customers, the factor pays you the reserve balances of the invoices, minus a fee for assuming the collection risk. Factoring is not a loan. No debt is assumed by factoring. The funds are unrestricted, providing a company more flexibility than with a traditional bank loan.

36 What are the Advantages of Factoring? There are several reasons why factoring is a valuable financial tool for many businesses. The key benefit is that factoring provides a quick boost to your cash flow. Many factoring companies provide cash on your accounts receivable within 24 hours. This can solve short-term cash flow issues and help fuel the growth of your business. Factoring companies handle your customer collections, and may also evaluate your customers credit and payment histories.

37 Some Other Major Benefits Include: Factoring can be customized and managed so that it provides necessary capital when your company needs it. The financing does not show up on your balance sheet as debt. Factoring is based on the quality of your customers credit, not your own credit or business history. Factoring provides a line of credit based on sales, not your company s net worth. Unlike a conventional loan, factoring has no limit to the amount of financing. Factoring aligns well with start-up businesses that need immediate cash flow.

38 Who Factors? Companies of all sizes, from one-person businesses to Fortune 500 corporations, use factoring as a way to increase their cash flow. Factoring spans all industries, including trucking, transportation, manufacturing and distribution, textiles, oil and gas. It is most common in industries such as clothing and toys. Companies use the cash generated from factoring to pay for inventory, buy new equipment, add employees, expand operations basically any expenses related to their business.

39 What is the Difference Between Recourse and Non-Recourse Factoring? Recourse means the client ultimately takes the responsibility for the payment of the invoice. Non-recourse factoring allows companies to sell their invoices to the factoring company, which assumes all of the credit risks for the collection of the invoice. Some factoring companies offer both recourse and non-recourse factoring.

40 What about Fees? There are, of course, costs to factoring, and the factor typically charges a fee of 1% or 2% for administration and a roughly similar sum for assuming the risk of nonpayment.

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