STRATEGIC FINANCIAL MANAGEMENT
OVERVIEW OF THE FINANCING DECISION
KHURAM RAZA
ACMA, MS FINANCE
First Principle and Big Picture
The Choices: Types of Financing
There are only two ways in which any business can raise
money
 Debt or Equity.
This may seem simplistic, given the array of choices firms have in
terms of financing vehicles. We will begin this section with a
discussion of the
 characteristics of debt and equity
 and then look at a range of financing vehicles available within each
of these categories.
 We will then examine of a range of securities that share some
characteristics with debt and some with equity and are therefore
called hybrid securities.
The Continuum between Debt and Equity
Debt is defined as any financing vehicle that is a
contractual claim on the firm (and not a function of
its operating performance), creates tax-deductible
payments, has a fixed life, and has a priority claim
on cash flows in both operating periods and in
bankruptcy.
Equity is defined as any financing vehicle that is a
residual claim on the firm, does not create a tax
advantage from its payments, has an infinite life,
does not have priority in bankruptcy, and provides
management control to the owner.
The Continuum between Debt and Equity
Fixed Claim
Tax Deductible
High Priority in Financial Trouble
Fixed Maturity
No Management Control
Debt
Residual Claim
Not Tax Deductible
Lowest Priority in Financial Trouble
Infinite
Management Control
Equity
Debt and Equity
Fixed Claim
Tax Deductible
High Priority in Financial Trouble
Fixed Maturity
No Management Control
Residual Claim
Not Tax Deductible
Lowest Priority in Financial Trouble
Infinite
Management Control
Debt
Bank Debt
Corporate Bonds
Leases
Equity
Hybrid Securities
Convertible Debt
Preferred Stock
Option-linked Bonds
Owner’s Equity
Venture Capital
Common Stock
Options/Warrants
Financing Choices and a Firm’s Life Cycle
Revenue/ Earnings
Financing Choices and a Firm’s Life Cycle
Time
Start-up
Owner’s
Equity
Bank Debt
Rapid
Expansion
Venture
Capital
Common
Stock
High Growth
Mature
Growth
Common
stock
Warrants
Convertibles
Debt /Bonds
Decline
Retire debt
Repurchase
stock
The Process of Raising Capital
Private Firm Expansion: Raising Funds from Private Equity
Provoke equity investor’s interest
Valuation and Return Assessment
Structuring the Deal
Post-deal Management
Exit
The Process of Raising Capital
From Private to Publicly Traded Firm: The Initial Public Offering
 Staying Private versus Going Public
 access to financial markets
 market value
 loss of control
 disclosure and legal requirements
Overall, the net tradeoff to going public will generally be positive for
firms with large growth opportunities and funding needs. It will be
smaller for firms that have smaller growth opportunities, substantial
internal cash flows, and owners who value the complete control
they have over the firm
Investment Sector
Traditional Underwriting
Value of
Rights
Investment Banker
Privileged Subscription
Terms of
Offering
Preemptive
Right
Saving Sector
Private Placement
Best Efforts Offering
Value of Rights
What gives a right its value?
A right allows you to buy new stock at a discount that
typically ranges between 10 to 20 percent from the
current market price.
The market value of a right is a function of :
P0 – S
• the market price of the stock
R0 =
N+1
• the subscription price
• the number of rights required to purchase an
additional share of stock
Example of the Valuation of
a Right
What is the value of a right when the stock is
selling “rights-on”? What is the value of one
share of stock when it goes “ex-rights”?
• Assume the following information:
• The current market price of a
stock “rights-on” is $50.
• The subscription price is $40.
• It takes nine rights to buy an additional share
of stock.
How is the Value of a
Right Determined?
Solving for R0.
R0 =
$50 – $40
9+1
R0 = $1
Solving for PX.
PX =
($50 )(9) + $40
PX = $49
9+1
Stock Market Efficiency
Stock Market Efficiency
Stock Market Efficiency
Stock Market Efficiency