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20model 10/6/2009 8:16 12/2/2002 Chapter 20. Model for analyzing hybrid financing alternatives In this model, we will examine four sources of long-term capital: preferred stock, leasing, warrants, and convertibles. Preferred stock is a hybrid security that represents a cross between debt and common equity. Leasing is used by financial managers as an alternative to borrowing to finance fixed assets. Warrants are derivative securities used by firms. Lastly, convertible securities are hybrids between debt and warrants. PREFERRED STOCK Commonly, preferred stock has a par value of $25 or $100. A preferred dividend is indicated as a percentage of par, or as dollars per share. Since preferred stock pays a perpetual dividend, its value is derived as the preferred dividend divided by the cost of preferred stock. Preferred stock's dividend yield, like common stock is the dividend paid divided by the value of the stock. PROBLEM A firm has sold 150,000 shares of $100 par value perpetual preferred stock (the total issue is $15 million). The preferred stock has a stated annual dividend of $12 per share. What is the dividend yield? Par value = $100 $12 Dividend yield = 12% LEASING Leasing provides firms with a flexible alternative when it comes to acquiring productive assets. Instead of buying fixed assets and having them on the balance sheet, companies may opt to lease. In 1997, about 30% of all new capital equipment acquired by businesses was leased. Leasing generally takes one of three forms: (1) sale-and-leaseback arrangements, (2) operating leases, and (3) straight financial, or capital, leases. A sale-and-leaseback arrangement is one whereby a firm sells land, buildings, or equipment and simultaneously leases the property back for a specified period under specific terms. An operating lease is one in which the lessor maintains and finances the property. A financial lease does not provide for maintenance services and is not cancelable. This kind of lease is fully amortized over its life (and therefore is also called a capital lease). Financial Statement Effects Lease payments are shown as operating expenses on a firm's income statement. Under certain conditions, neither the leased assets nor the liabilities under the lease contract appears on the firm's balance sheet. For these reasons, leasing is often called "off balance sheet financing". This can be illustrated by looking at the hypothetical firms, B and L. These two firms are identical in every way, except Firm B has decided to buy its new assets, while Firm L has chosen to lease. Before the increase in assets Firms B and L Curr. Assets 50 Debt 50 Debt Ratio Fixed Assets 50 Equity 50 50% Total Assets 100 100 D PS = A B C D E F G H I 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49
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After the increase in assets Firm B Curr. Assets 50 Debt 150 Debt Ratio Fixed Assets 150 Equity 50 75% Total Assets 200
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This note was uploaded on 05/31/2009 for the course MBA 4500 taught by Professor Eyupcetin during the Spring '09 term at Istanbul Technical University.

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