Chapter 15
An introduction of long-term financing
Corporate Finance
Course Lecture 1
Outline
Introduction of long-term financing;
Features of common and preferred stocks;
Corporate long-term debt;
Some different types of bonds.
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1. The Long-Term Financial gap
Uses of Cash
Flow (100%)
Sources of Cash
Flow (100%)
Capital
spending
80%
Internal
cash flow
(retained
earnings
plus
depreciation)
80%
Internal
cash flow
Long-term
debt and
equity 20%
External
cash flow
Net
working
capital
plus other
uses 20%
Financial
gap
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The long-term financing
• Total business spending has generally exceeded internally
generated cash flow and there has been a financial gap.
• The financial gap was made up by external financing.
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2. Features of common and preferred stocks
• Common stock features:
– Shareholder rights – the right to elect the directors;
• The mechanisms for electing directors: cumulative voting
and straight voting.
• For example, Smith has 20 shares and Jones has 80 shares.
Assuming 4 directors to be elected. In cumulative voting,
Smith has 20*4=80 votes and Jones has 80*4=320 votes. In
straight voting, Smith has 20 votes and Jones has 80 votes for
each candidate. Using cumulative voting, Smith will get a
seat of the board. Jones
Getting
Smith
Getting
support
candidates
votes
support
candidates
votes
A
81
E
80
B
81
..
C
81
D
77
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Features of common and preferred stocks
• Common stock features:
– Proxy voting – the authority by a shareholder to someone else to
vote her shares.
• The way of hostile takeovers – proxy fight
– Classes of stock – some firms have more than one class of
common stock.
• For example, Class A and B common stocks. Each Class A
share can be converted to 30 class B shares. (for company
control purposes)
– Dividends – shareholders has the right to obtain dividends as a
return of capital investment, but not guarantee.
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Features of common and preferred stocks
• Preferred stock features:
– Stated value – a stated liquidating value, usually $100 per share
and a stated dividend yield.
– Cumulative and noncumulative dividends – most are
cumulative.
• Unpaid preferred dividends are not debts of the firm. The
current preferred dividends must be paid before the
common shareholders can receive anything.
– Preferred stock is a kind of equity bond – It has a stated value
and dividend yield, but is often callable or convertible to
common stock.
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3. Corporate long-term debt
• The bond indenture – contract between the company and the
bondholders that includes:
– The basic terms of the bonds
– The total amount of bonds issued
– A description of property used as security, if applicable
– Sinking fund provisions
– Call provisions
– Details of protective covenants
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Term of bonds
• Corporate bonds usually have
– A face value (the principal value; par value);
– Registered form or bearer form;
– Security- Collateral and mortgages used to protect the
bondholder;
– Seniority- sometimes labeled as senior or junior to indicate
seniority.
• Additional terms
– Repayment – for example, sinking fund is an account managed
by the bond trustee, who then used the funds to retire a portion
of the debt.
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Term of bonds
• Additional terms
– Call provision – the company to repurchase part or all of the
bond issue at stated prices over a specific period.
• The difference between the call price and the stated value is
the call premium.
– Protective covenants – part of the indenture or loan agreement
that limits certain actions a company might otherwise wish to
take during the term of the loan.
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4. Some different types of bonds
• Floating Rate Bonds – the coupon payment is floating;
• Income bonds – coupon payments are dependent on company
income;
• Convertible bonds – bonds can be swapped for a fixed number
of shares of stock anytime before maturity.
• Put bonds – the issuer can buy bond back at a stated price.
– Securitized Bonds - Also called asset-backed bonds, Bondholders
receive interest and principal payments from a specific asset
rather than a specific company or government. For example,
mortgage, car loans and credit card-backed securitized bonds.
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