Long Term Financing Paper Final

Running head long pay Long-Term Financing University of Phoenix Online instauration to Finance and Accounting MMPBL-503 James R. Sullivan November 3, 2008 Long-Term Financing An established participation is considering expanding its operations, and to achieve their business clinicals, the stack volition conduct additional long-term slap-up memory boarding. Long-term funding involves debt or law instruments with great than one-year maturities, and the make up of this long-term swell whoremaster be sum upd using every the bully addition Pricing (CAPM) or Discounted nones Flows (DCFM) fashion influence.The boldness ordain conf go for to comp ar and contrast the capital Asset Pricing Model with the Discounted Cash Flows Model. The attainment of comparing and contrasting financial options will second evaluate and organize the debt/equity mix and dividend policy. The geological make upation must thus decide what type of long-term finance alternatives will close likely social welf ar. dandy Asset Pricing Model and the Discounted Cash Flows Model dandy Asset Pricing Model is a linear relationship between turn everyplaces on item-by-item shops and live bourgeon securities industry returns over time (Block & Hirt, 2005). angiotensin converting enzyme intention of CAPM is to analyze the performance of mutual currency and other portfolios (CAPM, 2008). Although, more than than one formula exists for the CAPM, the most rough-cut is referred to as the foodstuff endangerment subvention sit around give uped at a lower place (Block & Hirt, 2005) r = Rf + beta (Km Rf) Where r is the judge return look on a security measure Rf = the find loosen prescribe of return ( bills)B = beta coefficient, or historical volatility of joint stock proportional to market index Km = is the return foot mensuration of the appropriate asset class The market take chances premium formula assumes that the rate of return or premium demand ed by investors is directly proportional to the perceived risk of infection associated with the common stock. Beta measures the volatility of the security relative to the asset class. The equation is saying that investors require higher(prenominal) levels of expected returns to compensate them for higher expected risk.This formula slew be thought as predicting a securitys behavior as a function of beta CAPM says that if a individual knows a securitys beta accordingly they know the place of (r) that investors expect it to demand (see represent below) (CAPM, 2008). pic More volatile stocks will lay down a beta coefficient greater than 1. 0, whereas less volatile stocks will have a beta less than 1. 0. If the risk free rate of return (Rf) and average market return (Km) be considered located, then the required rate of return for completelyiance stock seat be manoeuverd for the required rate of return.As an example, if the market risk premium (Km Rf) is 6% and a risk free rate of return (Rf) is 4%, then the required rate of return would equal 10% for B = 1 and 16% for B = 2. The Discounted Cash Flow Model (DCFM) is a nonher standard bureau of determining the woo of equity. It assumes that a steadfastlys current stock worth is equal to the present (discounted) range of all expected upcoming dividends from the investment silver in hand (Utility Regulation, 2008). Modern financial theory contends that the price of a firms stock is the present value of the future cash flows discounted at an appropriate provoke rate (Freeman & Gagne, 1992).To calculate the current stock value, calculate the present value of future dividends and growth in the value of the stock at some future date. The discount rate employ for this present value calculation is the weighted average be of capital for the firm. Both the CAPM and DCF models involve applying data from a iodine or group of companies, to evaluate the current stock value of a single company. CAPM is m ore objective and complicated, and requires more calculation and data from the market. DCF is more inherent and simplified.One such(prenominal) DCF assumption is that future dividends will grow forever at a invariant rate. Since this assumption is not always true, the DCF method gives a more qualitative deem of the bell of capital. Limitations of CAPM allow ins, model uncertainty, it is difficult to know for sure if the use of the model is theoretically correct. In spew uncertainty, is another(prenominal) limitation, it is difficult to estimate the appropriate risk premiums accurately (CAPM limitations, 2008). Limitations of the DCF model take miss growth options, options to expand and options to redirect (DCFM, 2008).Debt/ faithfulness Mix Debt/equity mix is a financing strategy used by companies to succor fund the business or other investments. Most companies use a combination of both in found to ensure stability and to keep long-term cost down. Debt is the buy disclose ing of money from other lenders such as finance companies and banks. Corporate debt has increased dramatically in the last three decades. (Block & Hirt, pg. 468) Other forms of debt implicate topic alignments and leasing. Debt has become a common item on balance sheet for many companies, including those just starting signal out.Debt financing allows companies to finance without having to sell stock or bring in more partners. The major benefit for debt financing, unlike with equity financing, the proprietor retains full self-will of their business. Bringing in more partners or stock dribbleers in a company causes the loss of primary willpower and possibly the loss of the reason the company was created. beauteousness is another form of financing. Equity is also used by large and small companies. Equity is financed by other people. With equity financing the initial owner/ take oner has a greater risk of losing their company to the partners that have become involved.On the othe r hand the borrower in an equity finance loan has flexibility on repayment terms and the form of repayment (ie. cash, stock, bandages or services). However, most major corporations have a sort of debt and equity with making sure they do not have to practically leverage in either one. The formula for figuring out what a companys debt-equity ratio is (Block & Hirt) Debt/Equity Ratio = gist Liabilities Sh atomic number 18holders Equity Dividend Policy A companys dividend policy is up to the company and the profits that are made. If the company is just starting out they whitethorn not want to pay dividends to their stockholders.A setoff company may want to reinvest any net profit that are made in order to inspection and repair the company expand. In choosing either to pay a dividend to stockholders or to reinvest the cash in the company, managements starting line consideration is whether the firm will be able to earn a higher return for the stockholders (Block & Hirt, pg. 547) . When deciding on a dividend policy the stockholders penchant must be considered. The stockholder may or may not want to receive dividends and may only have concern with the value of their investment at relinquishment time.If expanding a business the dividends that are normally sent out will possibly be lower to help cover the cost of expanding. The expansion may also cause the dividends to increase. some investors care about he future shekels and the increase that may occur because of the expansion and lucre increase. Characteristics and Costs of Debt and Equity Instruments The purchasers of equity instruments have the rights to suffrage on issues, gain ownership and future wages of the business. Examples of equity instruments are common stock, preferred stock and maintained earnings. Ask Dr Econ, 2008) Common stock is a form of equity instruments, prefers are the common stockholders will share in the companys profitability, does not have to repay investment, dividends, and the votes cornerstone influence management. The discriminates of common stock, the vote may dilute the managements interest in the corporations growth, and the non-management stockholders can increase in the voting power, and the maximum risk falls on the investor. (Raymond, 2002) The cost of common equity is important as the ultimate ownership of the firm resides in common stock (Block & Hirt, 2005).The cost of publication recent common stock is expressed as Kn = D1 / (Po F) + g D1 = First year common dividend, Po = Price of common stock, F = Flotation change costs, g = Constant growth rate in earnings (Block & Hirt, 2005) favored stock is another form of equity instruments, improvements are stocks offers stipulated dividend on an annual or semi-annual basis, preference rights over common stock and dividend payments and liquidating distributions. The dividends can accrue at a certain rate and salaried on a cumulative basis.The disadvantage includes a subordination of divi dends to be paid on common stock and limitations on the use of merged fund to the extent that pre-established dividend payments. (Raymond, 2002) The cost of issuing new preferred stock is Kp = Dp ( Pp F) Where Dp = Preferred dividend, Pp = price of preferred stock, and F = Flotation change costs. (Block & Hirt, 2005) Retained earnings are kindred to ult and present earnings of the firm minus previously distributed dividends (Block & Hirt, 2005).In order to convince shareholders that earnings will equal larger dividends and equity later, it is important to calculate the present value of projected future cash flow. The equation for cost of retained earnings is equivalent to the cost of existing common stock Ke = D1 / Po + g This can be used to reacquire capital treasury stock at market price. The cost of retained earnings does not include the floatation or sales cost associated with new issues of common or preferred stock. (Block & Hirt, 2005) Debt instruments are requires a f ixed payment with interest, examples are confiscates, government or corporation and mortgages. Ask Dr Econ, 2008) Bondholders do not gain ownership, paid before other expenses, less risky and not entitle to future profits in the business. (Raymond, 2002). Disadvantages include potential restrictions on operations, limitations on the use of on the job(p) capital (Raymond, 2002). Bond financing includes the zero-coupon rate perplex and the floating rate trammel net. The cost of debt is measured by the after- impose cost of debt and must be calculated as follows Kd = Yield (1 t) where Yield = yield to due date and t = tax rateThe yield to adulthood of a bond is dependent on a number of variables annual interest payment, principal payment, bond price and years to maturity. The yield to maturity for a bond can be calculated using a bond table, or using the equation below Y = annual interest payment + (principal payment bond price) / years to maturity) (Block & Hirt, 2005) Evalua tion of Long-Term Financing Alternatives Organizations have several opportunities foralternative long-term financing to help the boldness expand and grow, raise capital expend by inflation and to supplement insufficient monetary resource generated internally by the giving medication.Debts for governing bodys have risen over the past three decades. Organizations are faced with the projection of continuing to raise capital to cover the organizations debts. Organizations can use bonds, stocks, leasing and other options as options for long-term financing Bonds Most large organizations use corporate bonds for long-term financing. The bond agreement specifies such basic items as the par value, the coupon rate, and the maturity date (Block & Hirt, 2005). The initial value of a bond is the bonds par value or face value. The interest rate on the bond is the coupon rate.The fluctuation of interest rank in the market affect the coupon rate of the bond after the bond has been issued. The ending date in which repayment of the principal of the bond is due is the maturity date. The bond agreement or indenture is the legitimate document that covers the bond from issuance to repayment. Organizations can put up a fastend bond offering such as a mortgage agreement, where specific assets are promised to bondholders should they default on the bond or study an unsecured, or debenture bond offering which doesnt specify a specific asset. Stocks Common stock is on way an organization can secure long-term equity financing.Common stock is issued at a price per share to relatives, friends and investors. The funds are used by the organization to help the organization grow. The organization can issued to stockholders as dividends to show a payback on the capital investment. The remaining funds after the organization pays out dividends become retained earnings for the organization and are reinvested back into the organization. Individuals who have ownership in the organization can hold preferred stock. Preferred stock holders are repaid first should the organization file for bankruptcy.Leasing Organizations can lease assets instead of financing them. Leasing can give an organization that is utterly on funds or is not reference worthy enough to borrow funds a way to obtain assets. Leasing an asset is generally more expensive than purchasing the asset. By leasing assets, the organization reduces cash outflow so they can use those funds for other ventures. Organizations can lease assets such as furniture, equipment and land. The organization can choose a jacket crown Lease agreement where the organization purchases the asset at the end of the lease period.Organizations in a higher tax bracket can take advantage of a depreciation write-off tax advantage by purchasing an asset and leasing the asset to another organization in a lower tax bracket. Other Alternatives Organizations can use Factoring to borrow capital. The factor generally charges higher interest rates than banks. Factors generally review credit history, but the organization may still be able to borrow due to the quality of the organizations indirect rather than their project projections. Conclusion Expanding a company can be a big step and many plans must be laid out and consider before the final decision can be made.Cost is the biggest factor that must be considered when expanding. The second factor to consider is who or how the cost is going to be covered. Most companies consider on that point finance options. Financing option that should be considered include taking on more debt, issuing bonds, and marketing stock. With these options the interest rate, the selling price of the stock and how much of the company they would like to give up all must be considered when choosing an option. The better option would be to do a mix of all of the financing options to keep the balance sheet leveled, and the company in good financial standing.References Ask Dr Econ. (2008) Federa l concord Bank of San FranciscoWhat are the differences between debt and equity markets? Retrieved October 31, 2008 from http//www. frbsf. org/ nurture/activities/drecon/answerxml. cfm? selectedurl=/2005/0510. html Block, S. B. , & Hirt, G. A. , (2005). Foundations of Financial Management (11th ed. ). New York McGraw-Hill. Capital Asset Pricing Model, (2008). Retrieved October 31, 2008, from http//www. moneychimp. com/glossary/capm/htm. Capital Asset Pricing Model