FINS1613 Lecture Notes - Department Of The Treasury (Australia), Telstra, Legal Separation

19 views7 pages

greyjackal640

16 Jun 2018

School

Department

Course

Professor

For unlimited access to Class Notes, a Class+ subscription is required.

Section II

Corporation

- Own legal entity distinct from owners

- Legal separation between ownership and management

Capital structure

- Source of financing is capital

- Capital structure is the ownership structure of corporation

o Debt, equity, outstanding securities

- Market value is the price investors are willing to pay for the cash flow and securities

- Face value is notational value to determine cash flow

- Book value is for accounting

Securities

- Financial instrument which gives investors rights to cash flow from the firm

o Debt and equity

- Securities can have different:

o Terms of the cash flow

o Rights of investors to enforce payment

o Ability of investors to influence decision making

Bond

- A security sold by governments and corporations to raise money from investors for promised future

payments (certain)

o Form of debt financing

- Terms will detail the amounts and dates of all payments

- Firm is obligated to make payments to the bond holders

o Go into administration (Australia)

o Go into bankruptcy (US)

- E.g. Telstra A$150m 7.75% Fixed Rate Notes were issued on 24 June 2010 and pay semi-annual

coupon payments beginning 15 Jan 2011until 15 July 2020

Government Bonds

- Risk free in developed countries e.g. Australian Treasury

Zero Coupon Bonds

- No coupon payments → coupon rate is zero

- YTM is total return anticipated on a bond when it matures (long term bond yield)

o Single discount rate that sets present value of bonds future worth/coupon payments

find more resources at oneclass.com

Unlock document

This preview shows pages 1-2 of the document.
Unlock all 7 pages and 3 million more documents.

Already have an account? Log in

Term Structure of Interest Rates

- Relationship between maturity and interest rate

- On a graph it is called zero-coupon yield curve

- Interest rates determined by supply and demand

o If majority want to borrow, interest rates will go up

o If majority want to lend, interest rates will go down

- Increase can encourage saving, decrease can encourage spending

- Factors which influence interest rates

o Inflation

o Current economy

o Expectations of future interest rates

o Risk

Inflation

- Nominal – rate money will grow if invested for certain period

- Inflation – measures how the purchasing power of given amount declines due to increasing price

- Real – rate of growth of purchasing power after adjusted for inflation

Long term bonds are more sensitive to interest

rate changes than short term bonds because

investors need to be compensated for the risk –

yield curves are generally upwards sloping

Economic Activity and Interest Rates

- Reserve Bank determines very short-term interest rates bc of rate banks borrow money overnight

- Reserve Bank can lower interest rates to stimulate economy vice versa

o Firm borrow money cheaper, lower project cost rate, higher project value, higher demand

- If interest rate expected to rise, long term rates will be higher than short term rates vice versa

Valuing Coupon Bonds

- Discounting each cash flow at rate from the yield curve matched to time

o Yield curve show the market interest rate per year for different maturity zero coupon bonds

o Find the yield to maturity corresponding to maturity of individual payment

find more resources at oneclass.com

Unlock document

This preview shows pages 1-2 of the document.
Unlock all 7 pages and 3 million more documents.

Already have an account? Log in

Document Summary

Capital structure is the ownership structure of corporation: debt, equity, outstanding securities. Market value is the price investors are willing to pay for the cash flow and securities. Face value is notational value to determine cash flow. Financial instrument which gives investors rights to cash flow from the firm: debt and equity. Securities can have different: terms of the cash flow, rights of investors to enforce payment, ability of investors to influence decision making. A security sold by governments and corporations to raise money from investors for promised future payments (certain: form of debt financing. Terms will detail the amounts and dates of all payments. Firm is obligated to make payments to the bond holders: go into administration (australia, go into bankruptcy (us) Telstra am 7. 75% fixed rate notes were issued on 24 june 2010 and pay semi-annual coupon payments beginning 15 jan 2011until 15 july 2020. Risk free in developed countries e. g. australian treasury.

Related Questions

Your firm has decided to spin off Android01 and Processor01 as a separate firm. The owners of the new firm will be equity holders and debt holders. After speaking with potential investors, investment banks have identified two possible capital structures (structure of equity and debt ownership):

Debt holders receive debt that pays them coupons of $2 million a year, and $30 million after 20 years (these are expected values as the coupons and principal payments are not riskless, the debt buyers realize the firms could default). They price the debt using a discount rate of 4 percent. Equity holders receive expected dividends of $3 million starting from year 5, and growing at a rate of 4 percent per year (a growing perpetuity). They price the equity using a discount rate of 7.5 percent.

Debt holders receive debt that pays them coupons of $1 million a year, and $12 million after 20 years (these are expected values as the coupons and principal payments are not riskless, the debt buyers realize the firms could default). They price the debt using a discount rate of 3.5 percent. Equity holders receive expected dividends of $3.9 million starting from year 5, and growing at a rate of 4.5 percent per year (a growing perpetuity). They price the equity using a discount rate of 7 percent.

Your firm receives all the proceeds from the sale debt and equity.

Prepare a Capital Budgeting and Cost of Capital report that answers the following Question 13.

Question 13: Which particular capital structure should be chosen for the spin-off?

Before starting your calculations, review the following materials:

cost of capital and choice of financing

equity, debt, and preferred stock

Submit your Capital Budgeting and Cost of Capital Report to the dropbox below.

pearbadger6

Question 1: In making Capital Structure decisions, the overall objective is to:
a)minimize the firm's WACC
b)improve cash flows as much as possible
c)maximize the tax deductions the firm receives for interest expense
d)minimize the total amount of dividends and interest the firm needs to pay

Question 2 options: Which of the below statements is true?
a)Equity financing is permanent financing, while debt financing is temporary financing
b)Debt is normally a less expensive form of capital than equity
c)corporations cannot make dividend payments to both common and preferred shareholders during the same year
d)both interest expense and dividend payments are tax deductible for the firm making them

Question 3 options: As a firm's debt increases, its _______________ also increases. This makes the firm more risky and tends to increase the firm's _____.
a)market value / expected return
b)expected return / expected dividend payout
c)leverage / beta
d)systematic risk / unsystematic risk

maroonraccoon228

Using the following information, write a one page narrative of what is found in the information below:

Please include answers to these two questions in the narrative.

Which firm would have the higher expected return between the unlevered equity holder and the levered equity holder? (show all the team calculations in arriving at the final answer).

2. How does the risk and cost of capital of levered equity compare to that of unlevered equity? Which is the superior capital structure choice for a perfect capital market, and why?

Expected CashFlow	=.50(Weak Cash Flows)+.50(strong Cash Flows)
Expected CashFlow	103,500.00
		NPV	$ 9,224.14	=-B6+(B2/(1+B7+B8))
			The investment has a positive NPV
		PV	$ 89,224.14	=+B2/(1+B9)
Cash Flow-weak economy	90,000.00
Cash Flow-strong economy	117,000.00
Initial Investment	80,000.00
Cost of Capital	16.00%
Risk-free Rate	5.00%

Cash Flows and Returns for Unlevered Equity
		Date 1: Cash Flow		Date 1: Return
		Strong	Weak	Strong	Weak
NPV	$ 9,224.14
PV	$ 89,224.14	117,000.00	90,000.00	31.13%	0.87%


Values & Cash Flows for Debt & Equity of the Levered Firm (Table 14.3)
	Date 0	Date 1: Cash Flow
	Initial Value	Strong Economy	Weak Economy
Debt	45,000	47,250	47,250
Levered equity		69,750	42,750
Firm	89,224	117,000	90,000


Returns to Equity with and without Leverage (Table 14.4)
	Date 0	Date 1: Cash Flow		Date 1: Returns
	Initial Value	Strong Economy	Weak Economy	Strong Economy	Weak Economy	Expected Return
Debt	45,000	47,250	47,250	5.00%	5.00%	5.00%
Levered Equity	44,224	69,750	42,750	57.72%	-3.33%	27.19%
Unlevered equity	89,224	117,000	90,000	31.13%	0.87%	16.00%


Systematic Risk and Risk Premiums for Debt, Unlevered Equity, and Levered Equity (Table 14.5)
	Return Sensitivity (Systematic Risk)	Risk Premium

Debt	0.00%	0.00%
Levered Equity	61.05%	0.00%	11.00%
Unlevered Equity	30.26%	-15.13%	22.19%

FINS1613 Lecture Notes - Department Of The Treasury (Australia), Telstra, Legal Separation

Document Summary

Get access

Related Documents

FINS1613 Lecture 3: FINS Week 3 Lect

FINS1613 Lecture Notes - Lecture 3: Common Stock, Dividend, Capital Structure

FINS1613 Lecture Notes - Lecture 3: Preferred Stock, Capital Structure, Government Debt

Related Questions