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Chapter 13&14

Chapter 13 & 14.docx

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Queen's University
COMM 103
Gary Bisonnette

Chapter 13: Introduction to Capital and Financial Markets - Key initial decision associated with formation of a business is the type of legal structure to be utilized o 5 main factors will influence final outcome 1. Ease of business set-up and operation  how easy it is to get a business up and running 2. The degree of control which an owner(s) desire(s) 3. The magnitude of risk an individual(s) is/are willing to take on level of financial, operation and legal liability which individuals are willing to accept 4. The capacity of an individual(s) to provide the financial needs required  financial resources which an individual has access to 5. The anticipated skills required for success - As the need if the organization change, or the level of risk magnifies, the need to adjust the legal structure increases Business Ownership Options - Sole Proprietorships o Easiest way to commence a business (register business) o If name of the business = name of owner, no formal registration o No creation of a separate legal business entity o Debts of the business = debts of the owner o Income earned by business = personal income of owner o Sole proprietor has 100% control of business but also 100% exposed to liabilities incurred o Skill set of business is limited to the skills possessed by the sole proprietor o Limited to own personal capacity to invest - Partnerships o Business formed by 2 or more individuals o Partnership agreement: outlines percentage of ownership; ensures that the expectations of each partner and the details of how the partnership is going to work, are fully understood by all partners involved o Not separate legal entities o Partnerships carry the obligation of "Joint and Several Liability"  each partner could be liable for total debs if other partners are unable to pay their portion of a Partnership's obligations o Problem in sharing of ownership and decision-making control o Financial capacity and skills expanded o Limited partners contribute equity capital but are not involved with management  General partners assumes full liability exposure  Limited liability partnership (LLP)  made up of both general partners an limited partners - Corporations o Creates a distinct legal entity that is separate from owners incorporation o More expensive and requires more paper work more time consuming o Establish a board of directors o Protects the owners by limiting their liability o Ownership rights are clearly defined (% of stocks) o Financial capacity and skills expanded o Ownership is privately held o Shares are not publicly traded occur as private transactions o Private corporations:  Ownership is privately held  Shares are not publicly traded occur as private transactions o Public Corporations:  Corporations whose shares of stocks are initially issued via an "Initial Public Offering" (IPO)  Stocks are traded on at least one stock exchange Sources of Funds - Funds Derived From Operations o Current-Year Operating Profits  Total Revenue – Total Operating Expenses o Retained Earnings dollar amount of net earnings an organization has accumulated - Debt Financing o Credit facilities are type of debt financing o Legal obligation to pay both interest, if applicable and principal when due regardless of the organization’s financial position o Short-Term Credit Facilities  Debt obligations for a short period of time (within one fiscal period)  Trade credit = accounts payable  Borrowing against accounts receivable or against line of credit (LOC) • Line of credit: a credit facility which gives the organization access to a pre-determined sum of money at a specified interest rate • Provides the organization with the ability to draw on account to meet frequent short-term capital needs • Borrowing money against future flow of AR means that it uses AR accounts as collateral o Long-Term Credit Facilities  Debt obligations over a time frame that exceeds a year  Bonds, mortgages, long-term notes, lease  Bonds • In return for funds, organization pays the holder of the bond an interest payment at regular intervals during which funds are borrowed • Purpose for bond is to raise capital for firm • By the end of the period, company pays the full amount borrowed, therefore organizations must establish reserves for these bonds prior to the date - Bond Issuance Process o Coupon rate: interest rate which the bond promises to pay on the face value of the bond  Two factors that determine coupon rate: • Risk-quality rating of the organization issuing the bond • Duration of the bond o Maturity date: day the principal payment is due o If bond repayment schedules are not met, bondholders have legal right to take action against organization issuing bond - Mortgage o Backed by real estate collateral o Sets a schedule of periodic payments for the full repayment of the debt over a period of time o Amortization period: length of time which the mortgage will be underwritten for - Long-Term Note: o Organization borrows amount of money with a defined interest rate schedule o Similar to mortgage but for shorter periods of time o Balloon payment: when a major portion of the principal is not included in period payments, but is deferred to a later date - Lease obligations: o Legal obligation to pay a service provider with an agreed upon amount of money o Lessor lends to lessee - Impact of credit facilities: o As managers, in making decisions to utilize debt financing as a source of funds for our business, we must ensure that the repayment obligations associated with the credit facilities undertaken do not jeopardize the liquidity and solvency of our organization Equity Options - Private Equity o Equity capital which is obtained from private sources  Eg. Contribution by owner(s), family, friends, or other initial backer, private equity firms or venture capitalists o Can either be direct monetary investment or monetary investment as a result of the issuance of stock (corporations) - Public Equity o Equity investments by investors as a result of the purchase of publicly- traded shares due to IPO or APO (secondary offering) Public-Equity Offering - Managers, board of directors and investment banking firm must determine if conditions are right for the laugh of an IPO or secondary offering - Managers when considering APO must consider impact on the current share value - Issuing additional shares can cause price dilution o Price dilution: the price of existing shares of stock will decline due to the fact that a larger number of shares exist - Market capitalization value: if MTR has 10,000,000 shares at $20 per share, its market cap is $200 million - Stock share issuance process takes time and money - Prospectus: required legal document which provides info relating to the current financial stability of the company and the intent of the share issuance Chapter 14: Understanding Financial Statements - Analyzing and interpreting financial statements is what enables a management team to keep its “fingers on the pulse” of the organization - Rely on 3 statements: income statement, balance sheet, cash flow statement o Provide information regarding an organization’s current liquidity and solvency position, overall financial capacity to respond to
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