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2007 Chapter 15-1

# 2007 Chapter 15-1 - Capital Budgeting Decisions Project...

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1 Capital Budgeting Decisions Project Financing Chapter 15

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2 Capital Budgeting Investment decisions related to fixed assets Investment decisions and financing decisions Financing Internal resources Retained earnings External resources Issuing stocks Issuing bonds Tax implications
3 Equity Financing Financing by retained earnings assumed so far in project evaluations Financing by issuing new securities Common stock share of ownership in a corporation - dividends Preferred stock earnings paid before Common Stock dividends & senior claim on assets

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4 Flotation costs investment bank, lawyers, accountants fees; etc Example 16.1: Capital Required: \$10mm Current Stock Price: \$30 Suggested Price for New Issue: \$28 Flotation Cost: 6% of the issue price How many shares must be sold? 28(1.0-0.06)N = \$ 10,000,000 N = 379,940 shares Flotation cost = \$ 638,300
5 Debt Financing Bond Financing fixed maturity period principal paid at maturity; par value interest paid each year Current Yield relates mkt price with future receipts Term Loans uniform payments of interest and principal

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6 Example 16.2: Debt Financing: \$10mm Bond Financing: Flotation cost: 1.8% 5 year bond; face value: \$1000; sale price: \$985 annual interest: 12% Worth of bonds sold: \$10,000,000/(1-0.018) = \$10.1833mm Floatation cost: \$183,300 Number of bonds sold: \$10,183,300/\$985 =10,338.38 Annual interest paid: \$10,338,380 x 0.12 = \$1,240,606 Full principal due on maturity Term Loan: 11% bank loan for 5 years Annual payments: \$10mm(A/P,11%,5) = \$2,705,703
7 BOND FINANCING 0 1 2 3 4 5 Beginning Balance \$10,338,380 \$10,338,380 \$10,338,380 \$10,338,380 \$10,338,380 \$10,338,380 Interest Owed 1,240,606 1,240,606 1,240,606 1,240,606 1,240,606 Repayment Interest Payment (1,240,606) (1,240,606) (1,240,606) (1,240,606) (1,240,606) Principal Payment (10,338,380) Ending Balance \$10,338,380 \$10,338,380 \$10,338,380 \$10,338,380 \$10,338,380 \$0 TERM LOAN FINANCING Beginning Balance \$10,000,000 \$10,000,000 \$8,394,297 \$6,611,967 \$4,633,580 \$2,437,570 Interest Owed 1,100,000 923,373 727,316 509,694 268,133 Repayment Interest Payment (1,100,000) (923,373) (727,316) (509,694) (268,133) Principal Payment (1,605,703) (1,782,330) (1,978,387) (2,196,009) (2,437,570) Ending Balance \$10,000,000 \$8,394,297 \$6,611,967 \$4,633,580 \$2,437,571 \$0

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8 Capital Structure Debt Ratio ratio of total debt to total capital effect of debt ratio on firm’s market value target capital structure (debt ratio) involves trade-off between risk and return debt interest is a deductible expense, dividends are not financial flexibility - ability to raise capital
9 Example 16.3 Project : \$10mm Life = 5 years Land = \$1mm

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