Long Term FinancingJoin now to read essay Long Term FinancingRunning Head: Long Term Financing AlternativesLong Term Financing AlternativesShellie N Phillips, Elias Hernandez, and Deborah StewartUniversity of PhoenixMBA 503Joey OliveriMarch 19, 2008IntroductionFirms need Capital to finance their assets. The need for long-term capital requires the firm to assure itself of having adequate capital at all times. Financing can be debt based, equity based or a mix of both. Debt is the cheapest form of financing, but it should be used only within reasonable limits, because use of debt beyond a reasonable point may increase the firm’s financial risk and drive up the costs of all sources of financing. This paper discusses the concepts of capital pricing models, debt/equity mix and dividend policy, evaluates various long-term financing alternatives and characteristics and costs of financial instruments, which are helpful to a firm intending to expand in the future.
Capital Asset Pricing Model (CAPM) with the Discount Cash Flow MethodsWhat is the cost of capital and how is it measured, what is its price? In order to get an accurate price of what capital is costing the firm the liability must be weighed out against its benefit. If the cost out weighs the benefit then there would be a negative return. When discussing capital funds we must consider the vehicles in which capital is raised. There is a price for Bonds, Preferred Stock, and Common Stock. The cost of debt or simply the cost of financing is arrived to by the interest rate, or yield, paid to bondholders. Preferred Stock is quite comparable to the cost of debt, the payment is consistent every year; however, there is no maturity date on the principle. The cost of a preferred stock is simply determined by the dividend over the current price. The cost of Common Equity (Common Stock) is much the same except that it Current Dividend over Market price. There are some variations and other factors that can be considered in determining this cost. There is no perfect model in evaluating stocks so many models competing for attentions. We will take a look at two popular models.. The Capital Asset Pricing Model (CAPM) and the Discount Cash Flow Methods (DCF). Each model has strengths and weaknesses which will need to be understood in order to determine which one to use. As all situations are unique, the methods chosen will be governed by the specifics of the situation.
The general idea behind CAPM is that stockholders need to be compensated in two ways: time value of money and risk. The time value of money is represented by the risk-free rate and compensates the stockholders for placing money in the company over a period of time. The other half of the formula represents risk and calculates the amount of compensation the stockholders needs for taking on additional risk. This is calculated by taking a risk measure that compares the returns of the asset to the market over a period of time and to the market index or premium. Another valuation method used to estimate the price of stock is DCF analysis DCF methods use future free cash flow projections and discounts them (most often using the weighted average cost of capital) to arrive at a present value, which is used to evaluate the value of the stock. If the value arrived at through DCF analysis is higher than the current cost of the investment, the opportunity may be a good one. Both methods or models need to be looked at to determine what the true value of a stock is.
Debt to Equity Mix and Dividend PolicyCorporations grow and so does their responsibility to the failure to integrate acquisitions and relationships successfully could hinder the success of the firm. Future acquisitions may be require the additional capital. This may be the company’s earnings or additional debt or equity financing. As the company continues to undertake strategic growth initiatives, one can reasonably assume that it will also continue to acquire the costs of additional in-process projects (Boston Scientific 2006 Annual Report). Reducing large amounts of debt, may require a portion of its operating cash flow to repay the debt. One way to pay large amounts of debt is to identify cost improvement measures, allowing for a better quality of revenue (profit margin). A company can also redistribute resources to better sustain growth goals. The firm could sell certain non-strategic assets
or a majority stake to another entity for capital that could be used to invest in other businesses, such as new manufacturing, services, or healthcare. The firm could also acquire the goodwill, a term that should be retained by the entity that held the intangible assets in the company that it is investing. If the firm holds those inaudible intangible assets, it will also need to transfer them and thus will potentially have to reinvest the intangible assets.
The investment rate of the firm could be significant. The value of assets that, for example, are valued in dollars, could be increased by 20 percent or more. For instance, a company could be interested in an acquisition of a large number of patents. This could result in an increase in a firm’s capital base to make up for the decrease in its capital due to the cost of capital. The impact of the initial purchase of many patents could also have an impact and a certain percentage of it would increase, giving the firm a less likely option to buy one.
At the same time, the firm could be interested in a wide range of activities, especially related to technology, manufacturing, and education. At times, the company may be looking at other businesses to develop, or may be considering acquisitions of a large number of businesses unrelated to the business of that unit or of that unit’s employees. For example, we will review the acquisition of a computer system maker. Under a common unit strategy, the firm focuses on building computer systems so that they can become a reliable, useful resource. This allows the firm to leverage new technologies to increase its revenue or reduce costs for suppliers of new software under the agreement, and provides an opportunity for capital for the company to build a new product (e.g., in the process of developing new products).
Bargaining in the development of intellectual property can be an interesting activity with a significant effect on the company’s consolidated financial statements, e.g., by influencing the price of a product. In many cases, certain other firms would be interested in taking advantage of the agreement. Such an arrangement might also be attractive to investors. If we consider the firm to be fully formed, which has been a likely scenario with a certain amount of debt, for example, a third entity could be involved or in a more limited number of operations. In such situations, an initial investment opportunity could lead to the firm being able to substantially reduce all of its debt by financing certain operations in place at the end of its third year.
At times, the firms may be interested in more flexible contractual arrangements that could produce an incremental loss of earnings. In this case, for example, the firm would sell some of its existing business and return equity to investors, without the need for a capital injection, to develop the necessary business operations such as hiring employees, capitalizing on available capital, and securing additional business investments (e.g., new research facilities, new research centers, computer systems, network technologies, new technology products).
In addition, if the firm has certain investment conditions such as certain long term contracts, or if these particular condition are entered into with the prior holder, it has some capacity to purchase, or to acquire, a substantial number of stock with no expectation of capital injection, e.g., debt. In general, however, under an initial investment commitment, a company may still be able to enter into any type of capital strategy and retain most necessary business operations. In these cases, the company is a much more passive company, which might invest and invest on investment opportunities that are not available in other activities.
If the firm would be willing to invest in another business, the company may