6Corporate_Financing_Overview

6Corporate_Financing_Overview - Corporate Financing...

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Corporate Financing Overview
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Firm Objective Maximize Value Capital Budgeting Decision Invest in projects that add value to the firm Financing Decision Maximize firm  value through optimal capital structure Payout Decision Return excess cash to investors to maximize shareholder wealth
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Financing Decision Maximize firm value through optimal capital structure Implement a capital structure with the optimal mix of equity and debt Issue the right kind of debt and equity securities to match assets
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Overview We begin with an overview of corporate financing How do firms fund their capital needs? What general types of securities might they issue? What are the characteristics of these securities? How does this actually take place in financial markets? How do firms issue securities?
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Funding Capital Requirements As we saw in the first half of the course, firms invest in projects that will add value to the company But, the capital to fund these projects must come from somewhere Where do firms get the capital to fund investment opportunities? Internal funds External Financing Issuing equity Issuing debt
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Internal Funds Through its operations, a firm creates cash flow during the year The firm makes a decision about how much of the cash to pay out to shareholders in the form of a dividend, and the rest of the cash is put back into the firm to fund new investment projects
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Equity and Debt In any given year, there is usually a difference between the amount of cash put back into the firm and the amount of cash needed to fund investment projects… the “financial deficit” Firms make up this financial deficit by issuing debt and equity securities in the market
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Funding Sources in the US Source: Brealey, Myers, & Allen -40 -20 0 20 40 60 80 100 120 Percent of total sourc 1991 1993 1995 1997 1999 2001 2003 2005 Year Internal Funds New Equity New Debt
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Do Firms Rely Too Much on Internal Funds? We saw that in the US, the overwhelming majority of capital for new investments comes from internal funds Similar in United Kingdom, Germany, and Japan Is this reliance on internal funds justified? Internal funds have advantages More convenient than outside sources Avoid cost of issuing new securities A new equity issue is generally bad news for investors Internal funds may be overused (or external funds underused) External funds provide more discipline Managers may avoid external funds to avoid increased scrutiny of their decisions
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How do firms fund the remainder of their capital needs? The relative use of debt and equity to fund capital needs varies widely Different industries have very different usages of equity and debt financing Specific firms may tend to use greater or lesser amounts of debt than others The use of debt in the United States has been gradually increasing in recent history Overall, the average debt-to-equity
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6Corporate_Financing_Overview - Corporate Financing...

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