Eseneco [5] Capital Financing

CAPITAL FINANCING

Capital Financing 

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Equity capital or ownership funds – those supplied and used by the owners of an enterprise in the expectation that a profit will be earned. Borrowed funds or capital – are those supplied by others on which a fixed rate of interest must be paid and the debt must be repaid at a specified time.

Types of Business Organizations 

Individual ownership

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Partnership

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Corporation

Individual Ownership 

Individual ownership or sole proprietorship is the simplest form of business organization, wherein a person uses his or her own capital to establish a business and is the sole owner.

Partnership 

A partnership is an association of two or more persons for the purpose of engaging in a business for profit.

Corporation 

A corporation is a distinct legal entity, separate from the individuals who own it, and which can engage in almost any type of business transaction in which a real person could occupy himself or herself.

Capitalization of a Corporation The capital of a corporation is acquired through the sale of stock. Two principal types of capital stock:  Common stock 

Preferred stock

Bonds 

A bond is a certificate of indebtedness of a corporation usually for a period not less than ten years and guaranteed by a mortgage on certain assets of the corporation or its subsidiaries.

Classification of Bonds According to the method of paying interest: 

Registered bonds

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Coupon bonds

Classification of Bonds According to the security behind the bonds: 

Mortgage bonds

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Collateral trust bonds

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Equipment obligation bonds

Classification of Bonds According to the security behind the bonds: 

Debenture bonds

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Joint bonds

Methods of Bond Retirement 

The corporation may issue another set of bonds equal to the amount of bonds due for redemption.

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The corporation may set up a sinking fund into which periodic deposits of equal amount are made. The accumulated amount in the sinking fund is equal to the amount needed to retire the bonds at the time they are due.

Example 1 

A bond issue of P200,000 in 10-year bonds, in P1,000 units, paying 16% nominal interest in semiannual payments, must be retired by the use of a sinking fund that earns 12% compounded semiannually. What is the total semiannual expense?

Value of a Bond 

The value of a bond is defined to be the present worth of all the amounts the bondholder will receive through his possession of the bond.

Let :  F = face, or par value  C = redemption or disposal price (often equal to F)  r = bond rate per period  n = number of periods before redemption  i = investment rate or yield per period  P = value of the bond n periods before redemption

Value of a Bond The bondholder will receive two types of payments: 



A single payment which the owner will receive at the date of maturity of the bond, which is usually equal to the par value of the bond; and The periodic payments for interest on the bond until it is redeemed by the issuing corporation.

Example 1 

A man wants to make 14% nominal interest compounded semiannually on a bond investment . How much should a man be willing to pay now for a 12% P10,000-bond that will mature in 10 years and pays interest semiannually?

Example 2 Mr. Romualdo bought a bond having a face value of P1,000 for P970. The bond rate was 14% nominal and interest payments were made to him semiannually for a total of 7 years. At the end of the seventh year, he sold the bond to a friend at a price that resulted a yield of 16% nominal on his investment. What was the selling price?

Example 2 Given: F = P1,000, i = 16%/2 = 8%, n = (7)(2) = 14 r = 14%/2 = 7%, P = P970, C = ?

I = Fr = (P1,000)(0.07) = P70 P = Fr (P/A, i%, n) + C (P/F, i%, n) P970 = P70 (P/A, 8%, 14) + C (P/F, 8%, 14) C = P 1,154.03

Example 3 A P1,000-bond which will mature in 10 years and with a bond rate of 8% payable annually is to be redeemed at par at the end of this period. If it is sold at P1,030, determine the yield at this price.

Example 3 Given: C = P1,000

P = P1,030 r = 8% n = 10

I = Fr = (P1,000)(0.08) = P80 P = Fr (P/A, i%, n) + C (P/F, i%, n) P1,030 = P80 (P/A, i%, 10) + P1,000 (P/F, i%, 10) Try i = 8% = P80 (P/A, 8%, 10) + P1,000 (P/F,8%, 10) = P1,000. Try i = 7% = P80 (P/A, 7%, 10) + P1,000 (P/F,7%, 10) = P1,070.24

i=?

Example 

A bond with a par value of P1,000 and with a bond rate of 10% payable annually is sold now for P1,080. if the yield is to be 12%, how much should the redemption price be at the end of 8 years?

Assignment 



A corporation sold an issue of 20-year bonds, having a total face value of P10,000,000 for P9,500,000. The bonds bear interest at 16% payable semi annually. The company wishes to establish a sinking fund for retiring the bond issue and will make semi annual deposits that will earn 12%, compounded semi annually. Compute the annual cost for the interest and redemption of these bonds. A man was offered a Land Bank certificate with a face value of P100,000 which bears interest of 8% per year payable semi annually and due in 6 years. If the man wants to earn 6% compounded semi annually, how much must he pay for the certificate?

Example 2 

A man was offered a Land Bank certificate with a face value of P100,000 which bears interest of 8% per year payable semi annually and due in 6 years. If the man wants to earn 6% compounded semi annually, how much must he pay for the certificate?