Chapter 14 - Raising Capital in the Financial Markets

1. Chapter 14 - Raising Capital in the Financial Markets Chapter 15 – Analysis and Impact of Leverage

2. TujuanPembelajaran 1 • MahasiswaMampuuntuk: • Memahamisumberdanainternal dan eksternal • Memahamibauranpembiayaan yang cenderungdigunakanperusahaan • Menjelaskanmengapa pasar keuangantimbul • Menjelaskankomponensistem pasar keuangan • Memahamiperanbankirinvestasidalamperolehan modal • Membedakanantarapenawaranterbatasdanpenawaranumum

3. PokokBahasan 1 • Sumberdanainternal dan eksternal • Bauransekuritasperusahaan yang dijual di pasar modal • Mengapa pasar keuanganmuncul • Pembiayaanperusahaan • Komponensistem pasar keuangan • Bankirinvestasi • PenawaranterbatasdanPenawaranumum

4. TujuanPembelajaran 2 • Mahasiswamampuuntuk: • Memahamiperbedaan antara risikokeuangan dan risikobisnis • Menggunakanteknikanalisistitikimpasuntukberbagaijenisanalisis • Membedakankonsepkeuangandari leverage operasi, leverage keuangan, danleveragegabungan • Menghitungdegree of operatingleverage, financialleverage, dan combinedleverage

5. PokokBahasan 2 • Risikobisnis dan keuangan • Analisistitikimpas • Operatingleverage • Financialleverage • Kombinasioperatingleverage dan financialleverage

6. Q: What are SECURITIES? A: Financial Assets that Investors purchase hoping to earn a high rate of return.

7. Types of Securities • Treasury Bills and Treasury Bonds • Municipal Bonds • Corporate Bonds • Preferred Stocks • Common Stocks Which of these are RISKY? Which promise HIGH RETURNS? Is there a relationship betweenRISK and RETURN?

8. Corporate FinancingSources From 1999 through 2001, capital has been raised through the following sources: • Corporate Bonds and Notes 76.9% • Equities 23.1%

9. cash saver securities Movement of Savings • Direct Transfer of Funds firm

10. funds funds saver investment banker firm securities securities Movement of Savings • Indirect Transfer using Investment Banker

11. funds funds financial intermediary saver firm intermediary securities firm securities Movement of Savings • Indirect Transfer using a Financial Intermediary

12. Financial Market Components Public Offering • Firm issues securities, which are made available to both individual and institutional investors. Private Placement • Securities are offered and sold to a limited number of investors.

13. Financial Market Components Primary Market • Market in which new issues of a security are sold to initial buyers. Secondary Market • Market in which previously issued securities are traded.

14. Financial Market Components Money Market • Market for short-term debt instruments (maturity periods of one year or less). Capital Market • Market for long-term securities (maturity greater than one year).

15. Financial Market Components Organized Exchanges • Buyers and sellers meet in one central location to conduct trades. Over-the-Counter (OTC) • Securities dealers operate at many different locations across the country. • Connected by Nasdaq system (National Association of Securities Dealers Automated Quotation system).

16. Investment Banking How do investment bankers help firms issue securities? • Underwriting the issue. • Distributing the issue. • Advising the firm.

17. Distribution Methods Negotiated Purchase • Issuing firm selects an investment banker to underwrite the issue. • The firm and the investment banker negotiate the terms of the offer. Competitive Bid • Several investment bankers bid for the right to underwrite the firm’s issue. • The firm selects the banker offering the highest price.

18. Distribution Methods Best Efforts • Issue is not underwritten. • Investment bank attempts to sell the issue for a commission. Privileged Subscription • Investment banker helps market the new issue to a select group of investors. • Usually targeted to current stockholders, employees, or customers.

19. Distribution Methods Direct Sale • Issuing firm sells the securities directly to the investing public. • No investment banker is involved.

20. Stock Issue Example: Our firm needs to raise approximately $100 million for expansion. Our stock price is $20. We Select Merrill Lynch to underwrite the issue for a 2% underwriting spread. • What type of issue is this? • It’s a negotiated purchase.

21. Stock Issue Example: Our firm needs to raise approximately $100 million for expansion. Our stock price is $20. We Select Merrill Lynch to underwrite the issue for a 2% underwriting spread. • How many shares will be sold? • $100,000,000 / $20 = 5 million new shares of common stock.

22. Stock Issue Example: Our firm needs to raise approximately $100 million for expansion. Our stock price is $20. We Select Merrill Lynch to underwrite the issue for a 2% underwriting spread. • What are the flotation costs? • Underwriting spread: 2% of $100 million = $2 million. • Issuing costs: printing and engraving costs; legal, accounting, and trustee fees.

23. Stock Issue Example: Our firm needs to raise approximately $100 million for expansion. Our stock price is $20. We Select Merrill Lynch to underwrite the issue for a 2% underwriting spread. • What are the risks? • The investment bank accepts the risk of being able to sell the new stock issue for $20 per share. If the stock price falls, the investment bank could lose money.

24. Regulations:The Primary Market The Securities Act of 1933 • Firms register with the Securities Exchange Commission (SEC). • SEC has 20 days to review. • SEC may ask for more information. • The firm cannot solicit buyers during the review period but can advertise.

25. Regulations:The Secondary Market The Securities Exchange Act of 1934 • Established the SEC. • Exchanges must register with SEC. • Company information must be available to the public. • Insider trading is regulated.

26. Regulations:Recent Developments Securities Acts Amendments of 1975 • Created National Market System. • Eliminated fixed brokerage commissions. SEC Rule 415 • Allows Shelf Registration

27. Chapter 15 – Analysis and Impact of Leverage • Operating Leverage • Financial Leverage

28. What is Leverage?

29. What is Leverage?

30. Two concepts that enhance our understanding of risk... 1) Operating Leverage - affects a firm’s business risk. 2) Financial Leverage - affects a firm’s financial risk.

31. Business Risk • The variability or uncertainty of a firm’s operating income (EBIT).

32. Stock- holders FIRM EPS EBIT Business Risk • The variability or uncertainty of a firm’s operating income (EBIT).

33. Business Risk Affected by: • Sales volume variability • Competition • Product diversification • Operating leverage • Growth prospects • Size

34. Operating Leverage • The use of fixed operating costs as opposed to variable operating costs. • A firm with relatively high fixed operating costs will experience more variable operating income if sales change.

35. EBIT Operating Leverage

36. Financial Risk • The variability or uncertainty of a firm’s earnings per share (EPS) and the increased probability of insolvency that arises when a firm uses financial leverage.

37. Stock- holders FIRM EPS EBIT Financial Risk • The variability or uncertainty of a firm’s earnings per share (EPS) and the increased probability of insolvency that arises when a firm uses financial leverage.

38. Financial Leverage • The use of fixed-cost sources of financing (debt, preferred stock) rather than variable-cost sources (common stock).

39. EPS Financial Leverage

40. Breakeven Analysis • Illustrates the effects of operating leverage. • Useful for forecasting the profitability of a firm, division, or product line. • Useful for analyzing the impact of changes in fixed costs, variable costs, and sales price.

41. Total Revenue $ Quantity

42. Costs Suppose the firm has both fixed operating costs (administrative salaries, insurance, rent, property tax) and variable operating costs (materials, labor, energy, packaging, sales commissions).

43. Total Revenue Total Cost $ } EBIT + - { FC Quantity Q1

44. } EBIT Total Revenue Total Cost $ + - { FC Quantity Q1 Break-even point

45. Operating Leverage What happens if the firm increases its fixed operating costs and reduces (or eliminates) its variable costs?

46. Total Revenue } $ EBIT + { Total Cost = Fixed - FC Quantity Q1 Break-even point

47. With high operating leverage, an increase in salesproduces a relatively larger increase in operating income.

48. Total Revenue } $ EBIT + { Total Cost = Fixed - FC Q1 Quantity Break- even point

49. Total Revenue } $ EBIT + { Total Cost = Fixed - FC Q1 Quantity Break- even point Trade-off: the firm has a higher breakeven point. If sales are not high enough, the firm will not meet its fixed expenses!

50. F P - V QB = Breakeven Calculations Breakeven point (units of output) • QB = breakeven level of Q. • F = total anticipated fixed costs. • P = sales price per unit. • V = variable cost per unit.