THE IMPACT OF FINANCING POLICY ON THE COMPANY S VALUE

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1 THE IMPACT OF FINANCING POLICY ON THE COMPANY S ALUE Pirea Marile Wes Uiversiy of Timişoara, Faculy of Ecoomics ad Busiess Admiisraio Boțoc Claudiu Wes Uiversiy of Timişoara, Faculy of Ecoomics ad Busiess Admiisraio Nicolescu Crisia Wes Uiversiy of Timişoara, Faculy of Ecoomics ad Busiess Admiisraio Naioal ad ieraioal fiacial sysem offers compaies a wide rage of fudig sources. The choice of oe or more of he available sources ad heir combiaio are major aspecs of he compay's fiacig policy. Maagers mus keep i mid ha he call o oe or oher of poeial fudig sources is o a mior ad idepede decisio, bu has profoud implicaios o he compay s value. Weighed average cos of capial ca be used as he discou rae or he selecio of ivesme projecs. Keywords: fiacig policy, cos of capial, capial srucure, compay s value. JEL code: G32 1. Iroducio Fiacig policy a microecoomic level is sigificaly iflueced by how he ecoomic mechaisms fucio a regioal, aioal ad eve global. Romaia is characerized by a relaively usable socio-ecoomic siuaio ad, which raises serious oll o he busiess resuls of Romaia compaies, irrespecive of qualiy maageme a he microecoomic level. Cosiderig he specifics of ecoomic ad fiacial evirome i he coex of aalysis of he ifluece hese areas have o he he fiace decisio a microecoomic level, oe cao igore elemes such as iflaio, chages i ieres raes or exchage rae i ecoomy 341. Alhough hese macroecoomic facors are especially useful for he subsaiaio of policy fiace compaies, here are oher facors ha ifluece fiacig policy, facors relaed o he compay's ieral evirome. Takig io accou hese observaios, ad various oher relaed o fiacig policies, we may woder why some secors of he aciviy ed o have compaies wih a high rae of borrowig compared o oher secors. Bu aalyzig he role of he fiacial lever, he cos sources of fudig or fees paid by he compay, we ca explai hese chages i borrowig raes, ad how he compay's value is affeced by he fiacig policy. 342 Amog hese facors, we cosider he cos of fiacig sources as he primary facor i foudaio fiacig policy, havig he greaes impac o compay resuls ad hece o is value. Fiacig policy, which uderpis he compay's capial formaio, is mosly assumed by he compay's maageme ad less by he "providers" of capial (shareholders, crediors). This ca be achieved i wo ways: ieral fiacig ad exeral fiacig. Bu each of hese sources implies a specific cos o achieve hem, cos which he maager should kow, cosiderig also he idirec implicaios of choosig oe or oher of hese fiacig arragemes. 341 Oprea Camelia, A aalyses of Romaia compaies fiacig decisio uder macroecoomic iflueces, MPRA Paper No 14716, Fabozzi F., Drake Pamela, Fiace. Capial Markes, Fiacial Maageme ad Ivesme Maageme, Joh Wiley & Sos, Ic, New Jersey,

2 2. The cos of fiacig sources eseial facor of compay policy Due o is crucial role i all producio facors, capial has a privileged posiio i all heoreical approaches aimed by busiess aciviy 343. So, we ca appreciae he capial as all fudig sources available o he compay ha ca be used o purchase all he elemes of he asse 344. Cosiderig he source of he compay`s capial is composed primarily of wo compoes: equiy ad deb The cos of equiy deermiaio mehods Equiy cos represes he rae of reur required by shareholders is he compay o pay for heir ivesme i he compay. If he rae of reur is lower ha he opporuiy cos, he he busiess value decreases, ad if he rae of reur is higher ha he opporuiy cos, he he busiess value icreases. The rae of reur expeced by shareholders is a opporuiy cos based o expeced reur of ivesors o ives he same risk. I he absece of resale rasacios of exisig shares, shareholders will ear divideds oly. If he fuure flow of divideds is kow, he discou rae ha equales he prese value of divideds by he curre price acio will be he required rae of reur for ivesors. The difficuly of he model lies i deermiig he exac level of fuure divideds. Therefore, research i he field ried o fid ways of esimaig his rae of reur expeced by ivesors, which he mos sigifica are preseed i he followig able: Mehods for deermiig he cos of equiy Cr. Nr. Mehod Formula Table 1 1 Gordo-Shapiro Model k e D 1 g (1) 2 Model of deermiig by PER (marke capializaio raio) : D = he divided yield per share 1 g = he growh rae of divided per share. 1 1 d(1 g) PER (4) ke g Rrf / EPS : d divided rae EPS earigs per share a ime /EPS = PER Model (CAPM) k e Rf [ E( R) Rf ] 3 Capial Asse Pricig 4 Arbirage Pricig Theory Model (APT) k e (6) : Rf risk-free ieres rae β Tile volailiy, sysemaic risk expressio relaive o marke porfolio E R expeced reur o marke porfolio k Rf K e b ik k1 (7) ik : b ik sesiiviy coefficie of he compay a he risk facor k k T 1 k (5) - average risk premium i he period uder review 343 Nisor I., Teorie şi pracică î fiațarea îrepriderilor, Ed. Casa Cărții de Şiiță, Cluj-Napoca, Berceau D., Deciziile fiaciare ale firmei, Ediția a II-a, Ed. Uiversiaria, Craiova,

3 T umber of periods aalyzed Rf - risk-free rae a ime K umber of risk facors 5 Updaed cash flow model, for preferred shares 6 Raa reabiliății fiaciare Div (1 k ) Div k (8) 1 p p : Div forecased divided o be disribued for year Div 1 =...= Div =Div = cosa k p cos of capial for preferred shares Rrf e Cpr (1) : π e e profi Cpr equiy value Source: Processig afer Pirea M., Crisea H., Nicolescu Crisia, Boțoc C., Maagemeul fiaciar al compaiei, Miro Publishig House, Timişoara, The cos of le capial - deermiaio mehods To esimae he cos of borrowed capial ca be used wo ypes of mehods: A. A compay`s exogeous mehods such as: - Negoiaios wih poeial maufacurers; - Based o marke ieres raes o loas wih similar risk issued isrumes; - Based o acual ieres rae subsidy payed by firms i he same secor. B. A compay`s edogeous mehods: I addiio o exogeous mehods, he compay ca esimae he cos of deb akig io cosideraio he ieres raes o loas issued by he compay, called yield o mauriy mehod, YTM. Yield o mauriy is he ieres rae ha would be wo by oe ivesor o similar isrumes, which bough he ile a he curre price ad ha keeps i uil mauriy. 345 The cos of borrowed capial will icrease over he yield o mauriy uder he impac of admiisraive coss, he various fees ivolved wih a ew issue. I hese circumsaces, he cos of deb (kd), uder he impac of axaio, is give by he followig formula: k d YTM 1 I (11) I π profi ax rae Oe of he sigifica risks ha are facig he crediors of compaies is he risk of defaul by he compay issuig deb (bakrupcy risk). Effec of bakrupcy risk should be cosidered i deermiig he discou rae, bu also he expeced value of cash-flow aalysis of ivesme projec sies. I hese circumsaces, esimaig he expeced profiabiliy by he crediors imposes he deermiaio of he paymes` sesiiviy, depedig o he macroecoomic idicaors. Therefore, a secod mehod for deermiig he cos of deb is he CAPM model, which ivolves calculaig he β coefficie for debs: k da, Rf da ER Rf (12) ude: Rf rae of reur o a risk-free bod a ime E R Rf - risk premium for he marke porfolio a ime 345 Sacu I., Fiațe, ediția a I-a, Ed. Ecoomică, Bucureşi,

4 Usig his formula, however, leads o deermiig he expeced value of reur o crediors, ha is usually differe from he acual value. The repor of he wo values is deermied by he risk of o-payme of obligaios o crediors ad he likelihood of bakrupcy. I case of he wo eves, he he acual amou will be less ha expeced value, oherwise beig above he expeced value The weighed average cos of capial -ifluece o he compay's fiacig policy Choosig a meas of fudig is deermied o he oe had by is cos ad secodly by he compay's curre fiacial srucure. 346 Opimal fiacial srucure correspods o he miimum cos of used capial, weighed average cos (WAC) beig deermied usig he followig relaio: ude: WAC w i k i (13) i1 w i shared capial, by he sources of origi k i -he cos of he i source of fiacig he umber of fiacig sources The priciple uderlyig he deermiaio of weighed average cos of capial calculaio akes io accou he WAC i accordace wih how he cash-flows ha have o be updaed are deomiaed. For his, he followig elemes should be cosidered: 1. The axaio of cash-flows. If hese are axed, he he CPM will be deermied afer axaio is pars: Debs Equiy WAC k debs(1 Iπ ) k e (14) Toalcapial Toalcapial 2. Usig omial raes, if cash-flows are expressed i omial sizes. WAC ca be used as discou rae i assessig cash-flows of a compay`s ivesme projecs. Usig WAC as he discou rae is a appropriae valuaio mehod based o updaig he sies of fuure cash flow, because he whole value of he compay has ivesed capial (ow or borrowed). Thus, he ecoomic asse value will be give by: CF R ar (15) 1 1 WAC (1 WAC) ude: CF cash-flows of he compay, o he hree ypes of aciviies ar value of reduda asses WAC calculaio proves is usefuless also i selecig ivesme projecs, beig he miimum hreshold below which ivesors will o accep o fall, represeig a ivesme reur required for he compay ha has a ideical risk of he same compay as a whole. If he ew projec has he same risk as a whole compay, he WAC ca be used i deermiig he e prese value (NP), as a crierio for selecio of ivesme projecs: CF NP I (16) 1 (1 WAC) ude: I value of iiial ivesme 346 Pirea M., Crisea H., Nicolescu Crisia, Boțoc C., Maagemeul fiaciare al compaiei, Ed. Miro, Timişoara,

5 CF aual forecas cash-flows forecas, afer ax. If he ivesme projec has a differe risk ha he compay`s, he he discou rae of cash flow may differ from he value of he compay`s WAC. I his case, he CAPM model is recommeded for deermiig he discou rae, i which he righ SML (Securiy Marke Lie) is he geomerical poi of all updaed raes of ivesmes, proporioally o he risk adjused o he raes of ivesme. 3. Creaig value effec of he compay`s decisios Iellige ivesme decisios make he shareholders richer. For example, if a compay ca borrow 8%, whe he ieres rae is 9%, he i ca be said ha he compay maager did a good deed for shareholders. Uforuaely, his is easier o be said ha doe. The problem is ha fiacial markes compeiio is more iese ha i mos produc markes. O produc markes, geerally, busiesses ca fid compeiive advaages ha allow posiive NP ivesmes. For example, a compay may have oly a few compeiors who specialize i he same lie of busiess ad i he same geographical area. Or ca be able o seize he pae, echology or o he recogiio ad cusomer loyaly. All hese offer he opporuiy o obai higher profis ad o fid posiive NP projecs 347. Bu here are few proeced iche i he fiacial markes ad you ca o pae issuace of ew securiies. I addiio, you are facig o hese markes always a fas-movig compeiio, icludig all oher compaies seekig capial, o eve cosiderig he sae, he local admiisraios, he fiacial isiuios, he foreig ad idividuals compaies ragig from New York, Tokyo or Lodo fudig. Ivesors who have a surplus capial are may ad iellige. Mos likely, hese ivesors assess he value of securiies a leas as well as issuers. Of course, whe a compay calls o loas, i was ha he borrowed resources o cos less ha marke ieres rae. Bu if he loa is a good deal for shareholders, i mus be a bad deal for crediors. So here is a dilemma liked o how a compay is likely o deceive ivesors cosaly forcig hem o pay a surcharge for he securiies issued. The aswer is very obvious, very small, geerally compaies should assume ha hey issue securiies which are sold a rue value. Bu he real value is a slippery poeial expressio, he acual fial value does o mea fuure value, because differeces may occur bewee predicios ad he acual recorded level (we do o expec ivesors o be observers by chace). Fair value reflecs a price which icludes all curre iformaio available o ivesors o a efficie capial marke, all securiies beig valued a a fair price. I such circumsaces, he sale of securiies a marke price ca ever be a posiive NP rasacio 4. Coclusios Fudig sources mus be seleced i accordace wih he objecives o fiace ad ecoomic evirome i which i operaes. Also, he compay's fiacial sraegy mus always follow he idicaors "e icome per share", "gross divided per share" or realisic "e divided per share" because ay ivesor bases his ivesme decisios accordig o acual earigs. For a capial ivesme o be jusified, he profiabiliy of ivesed resources mus a leas equal he same risk reur ivesme aleraives, ad we formulae he idea ha he cos of capial is a opporuiy cos. 347 Brealey R., Myers S., Marcus A., Fudameals of corporae fiace, 5 h Ediio, McGraw Hill/Irwi Publishig House, New York, USA,

6 If WAC aalysis is performed i erms of busiess, he we are alkig i erms of cos ha you mus pay for dispude sources of fudig. Bu aalysis ca be performed from he perspecive of ivesors who wish o obai a cerai gai from heir ivesme i he compay, ad he alk i erms of profiabiliy. All hese hypoheses argues ha i is hard o wi or lose based o fudig sraegies, eiher smar or supid. I is difficul o wi, which meas fidig cheap sources for fudig, because ivesors demad fair marke codiios. A he same ime, i's hard o lose, because compeiio amog ivesors preve ay of hem, i erms of requiremes, raher ha reasoable codiios. Refereces: 1. Berceau D., Deciziile fiaciare ale firmei, Ediția a II-a, Ed. Uiversiaria, Craiova, Brealey R., Myers S., Marcus A., Fudameals of corporae fiace, 5 h Ediio, McGraw Hill/Irwi Publishig House, New York, USA, Fabozzi F., Drake Pamela, Fiace. Capial Markes, Fiacial Maageme ad Ivesme Maageme, Joh Wiley & Sos, Ic, New Jersey, Nisor I., Teorie şi pracică î fiațarea îrepriderilor, Ed. Casa Cărții de Şiiță, Cluj- Napoca, Oprea Camelia, A aalyses of Romaia compaies fiacig decisio uder macroecoomic iflueces, MPRA Paper No 14716, Pirea M., Crisea H., Nicolescu Crisia, Boțoc C., Maagemeul fiaciar al compaiei, Ed. Miro, Timişoara, Sacu I., Fiațe, ediția a I-a, Ed. Ecoomică, Bucureşi,