Chapter 7 - 7-1CHAPTER 7Bonds and Their ValuationKey...

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Unformatted text preview: 7-1CHAPTER 7Bonds and Their ValuationKey features of bondsBond valuationMeasuring yieldAssessing risk7-2Corporate Financing MixFirst PrinciplesInvest in projects that yield a return greater than the minimum acceptable hurdle rate.The hurdle rate should be higher for riskier projects and reflect the financing mix used - owners funds (equity) or borrowed money (debt)Choose a financing mix that minimizes the hurdle rate and matches the assets being financed.If there are not enough investments that earn the hurdle rate, return the cash to stockholders.The form of returns - dividends and stock buybacks - will depend upon the stockholders characteristics.Objective: Maximize the Value of the Firm7-3Corporate Financing MixThe Choice in Financing:There are only two ways in which a business can make money. The first is debt. The essence of debt is that you promise to make fixed payments in the future (interest payments and repaying principal). If you fail to make those payments, you lose control of your business. The other is equity. With equity, you do get whatever cash flows are left over after you have made debt payments.The equity can take different forms:For very small businesses: it can be owners investing their savingsFor slightly larger businesses: it can be venture capitalFor publicly traded firms: it is common stockThe debt can also take different formsFor private businesses: it is usually bank loansFor publicly traded firms: it can take the form of bonds7-4Corporate Financing Mix7-5Measuring a firms financing mixThe simplest measure of how much debt and equity a firm is using currently is to look at the proportion of debt in the total financing. This ratio is called the debt to capital ratio: Debt to Capital Ratio = Debt / (Debt + Equity)Debt includes all interest bearing liabilities, short term as well as long term.Equity can be defined either in accounting terms (as book value of equity) or in market value terms (based upon the current price). The resulting debt ratios can be very different.7-6Costs and Benefits of DebtBenefits of DebtTax BenefitsAdds discipline to managementCosts of DebtBankruptcy CostsAgency CostsLoss of Future Flexibility7-7What managers consider important in deciding on how much debt to carry......
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This note was uploaded on 11/11/2011 for the course FIN 350 taught by Professor Chen during the Spring '07 term at S.F. State.

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Chapter 7 - 7-1CHAPTER 7Bonds and Their ValuationKey...

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