Chapter 14 Financing Sources PDF

Business Essentials Thirteenth Edition Chapter 14 Financing Sources Copyright © 2022, 2019, 2016 Pearson Education, Inc. Learning Outcomes 1 Explain the concept of the time value of money and the principl...

Business Essentials Thirteenth Edition Chapter 14 Financing Sources Copyright © 2022, 2019, 2016 Pearson Education, Inc. Learning Outcomes 1 Explain the concept of the time value of money and the principle of compound growth 2 Describe the role of securities markets and identify the major stock markets. 3 Describe the risk–return relationship and discuss the use of diversification and asset allocation for investments. 4 Describe the various ways that firms raise capital Copyright © 2022, 2019, 2016 Pearson Education, Inc. The Time Value of Money and Compound Growth Time Value of Money – principle that invested money grows, over time, by earning interest or some other form of return Compound Growth – compounding of interest over time—with each additional time period, interest returns accumulate Copyright © 2022, 2019, 2016 Pearson Education, Inc. The Rule of 72 You can find the number of years needed to double your money by dividing the annual interest rate (in percent) into 72. The Rule of 72 can also calculate how much interest you must get if you want to double your money in a given number of years: Simply divide 72 by the desired number of years. Copyright © 2022, 2019, 2016 Pearson Education, Inc. The Rule of 72 ✓The rule of 72 is an interesting concept. If we want to double our money, how many years will it take? Divide 72 by the interest rate you will receive. E.g. if you invest annually at 8%, you will double your money in about 9 years (72/8 = 9) Copyright © 2022, 2019, 2016 Pearson Education, Inc. The Rule of 72 To know how much interest you must get if you want to double your money in a given no. of years, divide 72 by the number of years in which you want this to occur. E.g. if you want to double your money in 10 years, you need to get 7.2% (72/10=7.2) Copyright © 2022, 2019, 2016 Pearson Education, Inc. Common Stock Investments Stock Common Stock – portion of ownership of – most basic form of a corporation ownership, including voting rights on major issues, in a company Copyright © 2022, 2019, 2016 Pearson Education, Inc. Stock Values Market Value – current price of a share of stock in the stock market Book Value – value of a common stock expressed as the firm’s owners’ equity divided by the number of common shares – When market value reaches book value investors are interested in buying stocks. Copyright © 2022, 2019, 2016 Pearson Education, Inc. Dividends Dividend – payment to shareholders, on a per-share basis, out of the company’s earnings Blue-Chip Stock – common stock issued by a well-established and respected company with a sound financial history and a stable pattern of dividend payouts Copyright © 2022, 2019, 2016 Pearson Education, Inc. The Business of Trading Securities (1 of 4) Securities – stocks, bonds, and mutual funds representing secured, or asset-based, claims by investors against issuers Securities Markets – markets in which stocks and bonds are sold Copyright © 2022, 2019, 2016 Pearson Education, Inc. The Business of Trading Securities (2 of 4) Primary Securities Market – market in which new stocks and bonds are bought and sold by firms and governments Secondary Securities Market – market in which existing (not new) stocks and bonds are sold to the public Copyright © 2022, 2019, 2016 Pearson Education, Inc. The Business of Trading Securities (3 of 4) Securities and Exchange Commission (SEC) – government agency that regulates U.S. securities markets – In Malaysia, it is called Securities Commission Malaysia - a statutory body entrusted with the responsibility of regulating and systematically developing the capital markets in Malaysia. Copyright © 2022, 2019, 2016 Pearson Education, Inc. The Business of Trading Securities (4 of 4) Investment Bank – financial institution that specializes in issuing and reselling new securities – Examples of investment banks in Malaysia: Affin Investment Bank Berhad, Hong Leong Investment Bank Berhad Copyright © 2022, 2019, 2016 Pearson Education, Inc. Stock Stock Exchange – an organization of individuals to provide an institutional auction setting in which stocks can be bought and sold In Malaysia, it is called Bursa Malaysia Copyright © 2022, 2019, 2016 Pearson Education, Inc. Tracking the Market Using Stock Indexes Market Index – statistical indicator designed to measure the performance of a large group of stocks or track the price changes of a stock market Copyright © 2022, 2019, 2016 Pearson Education, Inc. Tracking the Market Using Stock Indexes Bull Market Bear Market – period of rising stock – period of falling stock prices, lasting 12 prices marked by months or longer, negative investor featuring investor sentiments with confidence for future motivation to sell ahead gains and motivation to of anticipated losses buy Copyright © 2022, 2019, 2016 Pearson Education, Inc. Bull and Bear Markets Copyright © 2022, 2019, 2016 Pearson Education, Inc. The Risk–Return Relationship Risk-Return (Risk-Reward) Relationship – Each type of investment has a risk return relationship – Safer investments tend to offer lower returns – Riskier investments tend to offer higher returns Copyright © 2022, 2019, 2016 Pearson Education, Inc. Potential Financial Returns Rise with Riskier Investments Copyright © 2022, 2019, 2016 Pearson Education, Inc. Investment Dividends (or Interest), Appreciation, and Total Return (1 of 2) Current/Interest Dividend Yield – yearly dollar amount of income divided by the investment’s current market value, expressed as a percentage Price Appreciation – increase in the dollar value of an investment at two points in time (the amount by which the price of a security increases) Copyright © 2022, 2019, 2016 Pearson Education, Inc. Investment Dividends (or Interest), Appreciation, and Total Return (2 of 2) Capital Gain – profit realised from the increased value of an investment Total Return – the sum of an investment’s current dividend (interest) yield and capital gain Copyright © 2022, 2019, 2016 Pearson Education, Inc. Managing Risk with Diversification and Asset Allocation Diversification – purchase of several different kinds of investments rather than just one Asset Allocation – relative amount of funds invested in (or allocated to) each of several investment alternatives Portfolio – combined holdings of all the financial investments of any company or individual Copyright © 2022, 2019, 2016 Pearson Education, Inc. Financing a Business (1 of 2) Every company needs cash to function. If revenues are insufficient to pay for expenses, firms tap into various other sources of funds -- starting with the owners’ savings. If firm needs more money, they can turn to borrowing from banks, soliciting cash from private outside investors, or selling bonds to the public. Copyright © 2022, 2019, 2016 Pearson Education, Inc. Financing a Business (2 of 2) Firms can meet their capital needs through two sources: – Debt financing – Equity financing Copyright © 2022, 2019, 2016 Pearson Education, Inc. Debt financing Versus equity financing Debt Financing Equity Financing – long-term – using the owners’ borrowing from funds from inside sources outside the company as the a company source for long-term – E.g. long term funding loan or sale of – E.g. using retained corporate bonds earnings or issuing common stock Copyright © 2022, 2019, 2016 Pearson Education, Inc. Example of debt financing: Loans for Equipment Secured Loan (Asset-Backed Loan) – loan to finance an asset, backed by the borrower pledging the asset as collateral to the lender Collateral – asset pledged for the fulfillment of repaying a loan Unsecured Loan – loan for which collateral is not required – To meet short-term operating expenses Copyright © 2022, 2019, 2016 Pearson Education, Inc. Example of debt financing: Sale of Corporate Bonds (1 of 2) Corporate Bond – formal pledge obligating the issuer (the company) to pay interest periodically and repay the principal at maturity Bond Indenture – legal document containing complete details of a bond issue Copyright © 2022, 2019, 2016 Pearson Education, Inc. Example of debt financing: Sale of Corporate Bonds (2 of 2) Maturity Date (Due Date) – future date when repayment of a bond is due from the bond issuer (borrower) Face Value (Par Value) – amount of money that the bond buyer (lender) lent the issuer and that the lender will receive on repayment Copyright © 2022, 2019, 2016 Pearson Education, Inc. Example of equity financing: Becoming a Public Corporation Initial Public Offering (IPO) – first sale of a company’s stock to the general public Prospectus – registration statement filed with the SEC, containing information for prospective investors about a security to be offered and the issuing company Copyright © 2022, 2019, 2016 Pearson Education, Inc.