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Differences Between Financial Options and Real Options
Lecture Notes in Management Science (2012) Vol. 4: 169–178 4th International Conference on Applied Operational Research, Proceedings © Tadbir Operational Research Group Ltd. All rights reserved. www.tadbir.ca ISSN 2008-0050 (Print), ISSN 1927-0097 (Online) Differences between financial options and real options Tero Haahtela Aalto University, BIT Research Centre, Helsinki, Finland [email protected] Abstract. Real option valuation is often presented to be analogous with financial options valuation. The majority of research on real options, especially classic papers, are closely connected to financial option valuation. They share most of the same assumption about contingent claims analysis and apply close form solutions for partial difference equations. However, many real-world investments have several qualities that make use of the classical approach difficult. This paper presents many of the differences that exist between the financial and real options. Whereas some of the differences are theoretical and academic by nature, some are significant from a practical perspective. As a result of these differences, the present paper suggests that numerical methods and models based on calculus and simulation may be more intuitive and robust methods with looser assumptions for practical valuation. New methods and approaches are still required if the real option valuation is to gain popularity outside academia among practitioners and decision makers. Keywords: real options; financial options; investment under uncertainty, valuation Introduction Differences between real and financial options Real option valuation is often presented to be significantly analogous with financial options valuation. The analogy is often presented in a table format that links the Black and Scholes (1973) option valuation parameters to the real option valuation parameters. -
Initial Public Offerings
November 2017 Initial Public Offerings An Issuer’s Guide (US Edition) Contents INTRODUCTION 1 What Are the Potential Benefits of Conducting an IPO? 1 What Are the Potential Costs and Other Potential Downsides of Conducting an IPO? 1 Is Your Company Ready for an IPO? 2 GETTING READY 3 Are Changes Needed in the Company’s Capital Structure or Relationships with Its Key Stockholders or Other Related Parties? 3 What Is the Right Corporate Governance Structure for the Company Post-IPO? 5 Are the Company’s Existing Financial Statements Suitable? 6 Are the Company’s Pre-IPO Equity Awards Problematic? 6 How Should Investor Relations Be Handled? 7 Which Securities Exchange to List On? 8 OFFER STRUCTURE 9 Offer Size 9 Primary vs. Secondary Shares 9 Allocation—Institutional vs. Retail 9 KEY DOCUMENTS 11 Registration Statement 11 Form 8-A – Exchange Act Registration Statement 19 Underwriting Agreement 20 Lock-Up Agreements 21 Legal Opinions and Negative Assurance Letters 22 Comfort Letters 22 Engagement Letter with the Underwriters 23 KEY PARTIES 24 Issuer 24 Selling Stockholders 24 Management of the Issuer 24 Auditors 24 Underwriters 24 Legal Advisers 25 Other Parties 25 i Initial Public Offerings THE IPO PROCESS 26 Organizational or “Kick-Off” Meeting 26 The Due Diligence Review 26 Drafting Responsibility and Drafting Sessions 27 Filing with the SEC, FINRA, a Securities Exchange and the State Securities Commissions 27 SEC Review 29 Book-Building and Roadshow 30 Price Determination 30 Allocation and Settlement or Closing 31 Publicity Considerations -
The CEO's Guide to Corporate Finance
CORPORATE FINANCE PRACTICE The CEO’s guide to corporate finance Richard Dobbs, Bill Huyett, and Tim Koller Artwork by Daniel Bejar Four principles can help you make great financial decisions— even when the CFO’s not in the room. The problem Strategic decisions can be com- plicated by competing, often spurious notions of what creates value. Even executives with solid instincts can be seduced by the allure of financial engineering, high leverage, or the idea that well-established rules of eco- nomics no longer apply. Why it matters Such misconceptions can undermine strategic decision making and slow down economies. What you should do about it Test decisions such as whether to undertake acquisitions, make dives- titures, invest in projects, or increase executive compensation against four enduring principles of corporate finance. Doing so will often require managers to adopt new practices, such as justifying mergers on the basis of their impact on cash flows rather than on earnings per share, holding regular business exit reviews, focusing on enterprise-wide risks that may lurk within individual projects, and indexing executive compensation to the growth and market performance of peer companies. 3 The CEO’s guide to corporate finance It’s one thing for a CFO to understand the technical methods of valuation—and for members of the finance organization to apply them to help line managers monitor and improve company performance. But it’s still more powerful when CEOs, board members, and other non- financial executives internalize the principles of value creation. Doing so allows them to make independent, courageous, and even un- popular business decisions in the face of myths and misconceptions about what creates value. -
Outside Financing Capacity
Introduction Tirole’s Simple Credit Rationing Model Equity Multiplier Theory of Standard Debt Contracts Basic Assumptions (1) An entrepreneur (borrower). An investment project requiring fixed investment I. The entrepreneur has cash on hand (or liquid securities) A < I. To implement the project the entrepreneur needs (borrows) I − A. Robert J. Gary-Bobo Introduction Tirole’s Simple Credit Rationing Model Equity Multiplier Theory of Standard Debt Contracts Basic Assumptions (2) If undertaken the project either succeeds: verifiable income R > 0. Or the project fails: yields zero income. Let p denote the probability of success. The project is subject to moral hazard. Robert J. Gary-Bobo Introduction Tirole’s Simple Credit Rationing Model Equity Multiplier Theory of Standard Debt Contracts Basic Assumptions(3) The entrepreneur can exert high effort (work, take no private benefit), or zero effort (shirk, take a private benefit). Equivalently, the entrepreneur chooses between project with high or low probability of success. High effort yields p = pH ; low effort yields p = pL, with pL < pH . Denote ∆p = pH − pL. Low effort yields a private benefit B > 0 to the entrepreneur. (B can be interpreted as a disutility of effort). Robert J. Gary-Bobo Introduction Tirole’s Simple Credit Rationing Model Equity Multiplier Theory of Standard Debt Contracts Basic Assumptions (4) Borrower and lenders (investors) are risk-neutral. For simplicity, there is no time preference: investors require an interest rate equal to 0 (at least). The entrepreneur is protected by limited liability (income cannot be negative). Competition among lenders drive interest and profit to zero. Robert J. Gary-Bobo Introduction Tirole’s Simple Credit Rationing Model Equity Multiplier Theory of Standard Debt Contracts Basic Assumptions(5) The loan contract specifies how the profit is shared between borrower and lenders. -
Capital Structure Choice and the New High-Tech Firm
Capital Structure Choice and the New High-Tech Firm Robert J. Sheehan, MBA Student and J. Edward Graham, Assistant Professor of Finance, UNC-Wilmington Forthcoming in the 2001 Proceedings of the Academy of Economics and Finance Abstract This paper examines the capital structure choices of high tech firms in the last decade and how these choices relate to current capital structure theory. This theory includes the Static Trade Off Theory and the Pecking Order Theory; the former holds that firms make funding choices as a function of the firm’s overall weighted average cost of capital and seek primarily to minimize this cost of capital; the latter suggests that managers are loath to issue new equity, derive funds first from internal sources such as earnings, second from debt and finally from equity and equity-type issues. We find that high tech firms in the 1990s support, in some ways, the Static Trade Off suggestion that firms with strong and riskier growth options hold more cash that other firms and are more likely to draw initial funding from the equity markets. We find also that the market conditions of the 1990s allowed newer, smaller and riskier firms greater access to equity markets than ever before as a means of building large cash reserves. To account for this, we propose an extension of existing Pecking Order Theory and introduce a “Pecking Order Scale”. By viewing the key factors that influence capital structure choice as a continuum or scale from all equity on the left to all debt on the right, we are able to portray the capital structure choice of the firm based on individual firm, industry and overall market factors. -
The Promise and Peril of Real Options
1 The Promise and Peril of Real Options Aswath Damodaran Stern School of Business 44 West Fourth Street New York, NY 10012 [email protected] 2 Abstract In recent years, practitioners and academics have made the argument that traditional discounted cash flow models do a poor job of capturing the value of the options embedded in many corporate actions. They have noted that these options need to be not only considered explicitly and valued, but also that the value of these options can be substantial. In fact, many investments and acquisitions that would not be justifiable otherwise will be value enhancing, if the options embedded in them are considered. In this paper, we examine the merits of this argument. While it is certainly true that there are options embedded in many actions, we consider the conditions that have to be met for these options to have value. We also develop a series of applied examples, where we attempt to value these options and consider the effect on investment, financing and valuation decisions. 3 In finance, the discounted cash flow model operates as the basic framework for most analysis. In investment analysis, for instance, the conventional view is that the net present value of a project is the measure of the value that it will add to the firm taking it. Thus, investing in a positive (negative) net present value project will increase (decrease) value. In capital structure decisions, a financing mix that minimizes the cost of capital, without impairing operating cash flows, increases firm value and is therefore viewed as the optimal mix. -
The Importance of the Capital Structure in Credit Investments: Why Being at the Top (In Loans) Is a Better Risk Position
Understanding the importance of the capital structure in credit investments: Why being at the top (in loans) is a better risk position Before making any investment decision, whether it’s in equity, fixed income or property it’s important to consider whether you are adequately compensated for the risks you are taking. Understanding where your investment sits in the capital structure will help you recognise the potential downside that could result in permanent loss of capital. Within a typical business there are various financing securities used to fund existing operations and growth. Most companies will use a combination of both debt and equity. The debt may come in different forms including senior secured loans and unsecured bonds, while equity typically comes as preference or ordinary shares. The exact combination of these instruments forms the company’s “capital structure”, and is usually designed to suit the underlying cash flows and assets of the business as well as investor and management risk appetites. The most fundamental aspect for debt investors in any capital structure is seniority and security in the capital structure which is reflected in the level of leverage and impacts the amount an investor should recover if a company fails to meet its financial obligations. Seniority refers to where an instrument ranks in priority of payment. Creditors (debt holders) normally have a legal right to be paid both interest and principal in priority to shareholders. Amongst creditors, “senior” creditors will be paid in priority to “junior” creditors. Security refers to a creditor’s right to take a “mortgage” or “lien” over property and other assets of a company in a default scenario. -
Announcement Has Been Approved for Release by the Board
ASX RELEASE 19 JULY 2021 ASX:NES RENOUNCEABLE RIGHTS ISSUE TO RAISE UP TO $2 MILLION • 2 for 7 Renounceable Rights Issue to raise up to $2 million • Attractively priced at 4.7 cents per share • Discount of 20% to the 10-day VWAP of 5.9 cents and 31% to the 90-day VWAP of 6.8 cents • With every two New Shares, shareholders receive one free attaching New Option • New Options will have Exercise Price of 8 cents, term of two years and will be listed • Shareholders can trade their rights and apply for additional shares and options • Rights to start trading from 23 July 2021 • Directors to participate for their full entitlement and will sub-underwrite a portion of the shortfall • Funds to be used to complete current drilling programs and expand upon the company’s exploration programs at its Woodline and Tempest projects. Nelson Resources Limited (ASX: [ASX]) (“Nelson Resources” or “the Company”) is pleased to announce a Renounceable Rights Issue to raise up to $2 million to fund completion of its current drilling programs and expand upon its exploration programs at its Woodline and Tempest projects. These expanded programs will include additional drilling and geophysics programs to be conducted with the company’s wholly owned drilling and geophysics equipment. Under the offer, shareholders will be offered two New Shares for every seven existing shares held on 26 July 2021 (“Record Date”), with one attaching listed Option, exercisable at $0.08 and expiring on 31 August 2023, for every two New Shares subscribed. The rights issue price represents a discount of: • 20% to the Company’s 10 day VWAP of $0.059; and • 31% to the Company’s 90 day VWAP of $0.068. -
Corporate Finance Lecture Note Packet 2 Capital Structure, Dividend Policy and Valuation
Aswath Damodaran 1 CORPORATE FINANCE LECTURE NOTE PACKET 2 CAPITAL STRUCTURE, DIVIDEND POLICY AND VALUATION Aswath Damodaran Spring 2016 Aswath Damodaran 2 CAPITAL STRUCTURE: THE CHOICES AND THE TRADE OFF “Neither a borrower nor a lender be” Someone who obviously hated this part of corporate finance First principles 3 Aswath Damodaran 3 The Choices in Financing 4 ¨ There are only two ways in which a business can raise money. ¤ The first is debt. The essence of debt is that you promise to make fixed payments in the future (interest payments and repaying principal). If you fail to make those payments, you lose control of your business. ¤ The other is equity. With equity, you do get whatever cash flows are left over after you have made debt payments. Aswath Damodaran 4 Global Patterns in Financing… 5 Aswath Damodaran 5 And a much greater dependence on bank loans outside the US… 6 Aswath Damodaran 6 Assessing the existing financing choices: Disney, Vale, Tata Motors, Baidu & Bookscape 7 Aswath Damodaran 7 8 The Transitional Phases.. 9 ¨ The transitions that we see at firms – from fully owned private businesses to venture capital, from private to public and subsequent seasoned offerings are all motivated primarily by the need for capital. ¨ In each transition, though, there are costs incurred by the existing owners: ¤ When venture capitalists enter the firm, they will demand their fair share and more of the ownership of the firm to provide equity. ¤ When a firm decides to go public, it has to trade off the greater access to capital markets against the increased disclosure requirements (that emanate from being publicly lists), loss of control and the transactions costs of going public. -
Who Regulates Whom? an Overview of the US Financial Regulatory
Who Regulates Whom? An Overview of the U.S. Financial Regulatory Framework Updated March 10, 2020 Congressional Research Service https://crsreports.congress.gov R44918 Who Regulates Whom? An Overview of the U.S. Financial Regulatory Framework Summary The financial regulatory system has been described as fragmented, with multiple overlapping regulators and a dual state-federal regulatory system. The system evolved piecemeal, punctuated by major changes in response to various historical financial crises. The most recent financial crisis also resulted in changes to the regulatory system through the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010 (Dodd-Frank Act; P.L. 111-203) and the Housing and Economic Recovery Act of 2008 (HERA; P.L. 110-289). To address the fragmented nature of the system, the Dodd-Frank Act created the Financial Stability Oversight Council (FSOC), a council of regulators and experts chaired by the Treasury Secretary. At the federal level, regulators can be clustered in the following areas: Depository regulators—Office of the Comptroller of the Currency (OCC), Federal Deposit Insurance Corporation (FDIC), and Federal Reserve for banks; and National Credit Union Administration (NCUA) for credit unions; Securities markets regulators—Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC); Government-sponsored enterprise (GSE) regulators—Federal Housing Finance Agency (FHFA), created by HERA, and Farm Credit Administration (FCA); and Consumer protection regulator—Consumer Financial Protection Bureau (CFPB), created by the Dodd-Frank Act. Other entities that play a role in financial regulation are interagency bodies, state regulators, and international regulatory fora. Notably, federal regulators generally play a secondary role in insurance markets. -
What Is Corporate Finance? Includes Any Decisions Made by a Business
1 Lecture I What is Corporate Finance? Includes any decisions made by a business that affect its finances Three major decisions: • Investments: Where should a firm invest its (scarce) resources? - project analysis - security analysis • Financing: How should the firm raise (additional) resources? - equity/debt/hybrids - long/short term • Dividend decision: What should the firm do with excess resources? - reinvest in business - distribute as dividends/return on capital BAFI 402: Financial Management I, Fall 2001 A. Gupta 2 Lecture I Corporate Finance – a balance sheet perspective Balance Sheet Current Assets Current Liabilities Cash Accounts Payable Accounts Receivable Notes Payable Inventory Long-term Debt Fixed Assets Shareholder’s Equity Tangible Common Stock Intangible Retained Earnings Total Assets Total Liabilities & Equity _________________ ____________________ Investment decisions Financing decisions Two separate decisions BAFI 402: Financial Management I, Fall 2001 A. Gupta 3 Lecture I The objective of the firm Why do we need an objective function? - How do you pick amongst alternatives? (e.g. NPV rule for projects) - Single/multiple objectives – if multiple, how do you weight objectives, or prioritize? (e.g. man serving many masters!) What’s a good objective function? - clear and unambiguous (should not vary from case to case and person to person) - measurable, in a clear and timely manner (“social welfare” – how do you measure it?) - no side costs - should benefit firm’s long-term health and value What are some common candidates for the objective function of a corporate firm (and hence the financial manager?)? BAFI 402: Financial Management I, Fall 2001 A. Gupta 4 Lecture I The Corporate Objective • In traditional corporate finance , the objective of the firm is to maximize the value of the firm. -
Corporate Finance and Monetary Policy!
Corporate Finance and Monetary Policy Guillaume Rocheteau University of California, Irvine Randall Wright University of Wisconsin, Madison; FRB Chicago and FRB Minneapolis Cathy Zhang Purdue University This version: January 2016 Abstract This paper provides a theory of external and internal …nance where entrepreneurs …nance random investment opportunities with …at money, bank liabilities, or trade credit. Loans are distributed in an over-the-counter credit market where the terms of the loan contract, including size, rate, and down payment, are negotiated in a de- centralized fashion subject to pledgeability constraints. The model has implications for the cross-sectional distribution of corporate loan rates and loan sizes, interest rate pass-through, and the transmission of monetary policy (described either as money growth or open market operations) with or without liquidity requirements. JEL Classi…cation Numbers: D83, E32, E51 Keywords: Money, Credit, Interest rates, Corporate Finance, Pledgeability. We thank Sebastien Lotz for his input and comments on a preliminary version of the paper, and many people for input on this and related work. We also thank conference participants at the 2015 WAMS-LAEF Workshop in Sydney for useful feedback and comments. Wright acknowledges support from the Ray Zemon Chair in Liquid Assets at the Wisconsin School of Business. The usual disclaimers apply. 1 Introduction It is commonly thought (and taught) that monetary policy in‡uences the real economy by setting short-term nominal interest rates that a¤ect the real rate at which households and …rms borrow. While perhaps appealing heuristically, it is not easy to model this rigor- ously. One reason is that it arguably requires, among other things, an environment where money, credit, and government bonds coexist.