chapter 14 - raising capital in the financial markets

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Chapter 14 - Raising Capital in the Financial Markets

Chapter 15 – Analysis and Impact of Leverage

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Tujuan Pembelajaran 1

Mahasiswa Mampu untuk:Memahami sumber dana internal dan eksternalMemahami bauran pembiayaan yang cenderung digunakan perusahaan Menjelaskan mengapa pasar keuangan timbul Menjelaskan komponen sistem pasar keuanganMemahami peran bankir investasi dalam perolehan modal Membedakan antara penawaran terbatas dan penawaran umum

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Pokok Bahasan 1

Sumber dana internal dan eksternalBauran sekuritas perusahaan yang dijual di pasar modalMengapa pasar keuangan munculPembiayaan perusahaanKomponen sistem pasar keuanganBankir investasiPenawaran terbatas dan Penawaran umum

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Tujuan Pembelajaran 2

Mahasiswa mampu untuk: Memahami perbedaan antara risiko keuangan dan risiko bisnisMenggunakan teknik analisis titik impas untuk berbagai jenis analisisMembedakan konsep keuangan dari leverage operasi, leverage keuangan, dan leverage gabunganMenghitung degree of operating leverage, financial leverage, dan combined leverage

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Pokok Bahasan 2

Risiko bisnis dan keuanganAnalisis titik impasOperating leverageFinancial leverageKombinasi operating leverage dan financial leverage

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Q: What are SECURITIES?

A: Financial Assets that Investors purchase hoping to

earn a high rate of return.

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Types of SecuritiesTreasury Bills and Treasury BondsMunicipal BondsCorporate BondsPreferred StocksCommon Stocks

Which of these are RISKY?Which promise HIGH RETURNS?Is there a relationship between RISK

and RETURN?

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Corporate FinancingSources

From 1999 through 2001, capital has been raised through the following sources:

Corporate Bonds and Notes 76.9%Equities 23.1%

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Movement of SavingsDirect Transfer of Funds

cash

securities

saver

firm

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Movement of SavingsIndirect Transfer using Investment Banker

securities

fundsfunds

securities

saver

investmentbanker firm

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Movement of SavingsIndirect Transfer using a Financial Intermediary

funds

intermediarysecurities

funds

firmsecurities

financialintermediary firm

saver

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Financial Market Components

Public OfferingFirm issues securities, which are made available to both individual and institutional investors.

Private PlacementSecurities are offered and sold to a limited number of investors.

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Financial Market Components

Primary MarketMarket in which new issues of a security are sold to initial buyers.

Secondary MarketMarket in which previously issued securities are traded.

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Financial Market Components

Money MarketMarket for short-term debt instruments (maturity periods of one year or less).

Capital MarketMarket for long-term securities (maturity greater than one year).

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Financial Market Components

Organized ExchangesBuyers and sellers meet in one central location to conduct trades.

Over-the-Counter (OTC)Securities dealers operate at many different locations across the country.Connected by Nasdaq system (National Association of Securities Dealers Automated Quotation system).

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Investment Banking

How do investment bankers help firms issue securities?

Underwriting the issue.Distributing the issue.

Advising the firm.

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Distribution Methods Negotiated Purchase

Issuing firm selects an investment banker to underwrite the issue.The firm and the investment banker negotiate the terms of the offer.

Competitive BidSeveral investment bankers bid for the right to underwrite the firm’s issue.The firm selects the banker offering the highest price.

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Distribution Methods

Best EffortsIssue is not underwritten.Investment bank attempts to sell the issue for a commission.

Privileged SubscriptionInvestment banker helps market the new issue to a select group of investors.Usually targeted to current stockholders, employees, or customers.

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Distribution Methods

Direct SaleIssuing firm sells the securities directly to the investing public.No investment banker is involved.

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Stock Issue Example:Our firm needs to raise approximately

$100 million for expansion. Our stock price is $20. We Select Merrill Lynch to underwrite the issue for a 2% underwriting spread.

What type of issue is this?It’s a negotiated purchase.

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Stock Issue Example:Our firm needs to raise approximately

$100 million for expansion. Our stock price is $20. We Select Merrill Lynch to underwrite the issue for a 2% underwriting spread.

How many shares will be sold?$100,000,000 / $20 = 5 million new shares of common stock.

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Stock Issue Example:Our firm needs to raise approximately

$100 million for expansion. Our stock price is $20. We Select Merrill Lynch to underwrite the issue for a 2% underwriting spread.

What are the flotation costs?Underwriting spread: 2% of $100 million = $2 million.Issuing costs: printing and engraving costs; legal, accounting, and trustee fees.

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Stock Issue Example:Our firm needs to raise approximately

$100 million for expansion. Our stock price is $20. We Select Merrill Lynch to underwrite the issue for a 2% underwriting spread.

What are the risks?The investment bank accepts the risk of being able to sell the new stock issue for $20 per share. If the stock price falls, the investment bank could lose money.

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Regulations:The Primary Market

The Securities Act of 1933 Firms register with the Securities Exchange Commission (SEC). SEC has 20 days to review.

SEC may ask for more information.The firm cannot solicit buyers during the review period but can advertise.

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Regulations:The Secondary Market

The Securities Exchange Act of 1934Established the SEC.Exchanges must register with SEC.Company information must be available to the public.Insider trading is regulated.

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Regulations:Recent Developments

Securities Acts Amendments of 1975Created National Market System.Eliminated fixed brokerage commissions.

SEC Rule 415Allows Shelf Registration

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Operating LeverageFinancial Leverage

Chapter 15 – Analysis and Impact of Leverage

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What is Leverage?

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What is Leverage?

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Two concepts that enhance our understanding of risk...

1) Operating Leverage - affects a firm’s business risk.

2) Financial Leverage - affects a firm’s financial risk.

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Business Risk

The variability or uncertainty of a firm’s operating income (EBIT).

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Business Risk

The variability or uncertainty of a firm’s operating income (EBIT).

FIRMEBIT EPSStock-holders

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Business Risk

Affected by:Sales volume variabilityCompetitionProduct diversificationOperating leverageGrowth prospectsSize

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Operating Leverage

The use of fixed operating costs as opposed to variable operating costs.A firm with relatively high fixed operating costs will experience more variable operating income if sales change.

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EBIT

OperatingLeverage

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Financial Risk

The variability or uncertainty of a firm’s earnings per share (EPS) and the increased probability of insolvency that arises when a firm uses financial leverage.

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Financial Risk

The variability or uncertainty of a firm’s earnings per share (EPS) and the increased probability of insolvency that arises when a firm uses financial leverage.

FIRMEBIT EPSStock-holders

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Financial Leverage

The use of fixed-cost sources of financing (debt, preferred stock) rather than variable-cost sources (common stock).

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EPS

FinancialLeverage

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Breakeven Analysis

Illustrates the effects of operating leverage.Useful for forecasting the profitability of a firm, division, or product line.Useful for analyzing the impact of changes in fixed costs, variable costs, and sales price.

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Quantity

$

Total Revenue

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Costs

Suppose the firm has both fixed operating costs (administrative salaries, insurance, rent, property tax) and variable operating costs (materials, labor, energy, packaging, sales commissions).

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Quantity{

$

Total Revenue

Total Cost

FC

Q1

+

-

} EBIT

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Quantity{

$

Total Revenue

Total Cost

FC

Break-evenpoint

Q1

+

-

} EBIT

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Operating Leverage

What happens if the firm increases its fixed operating costs and reduces (or eliminates) its variable costs?

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Quantity

{

$

Total Revenue

Total Cost= FixedFC

Break-evenpoint

}

Q1

+

-

EBIT

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With high operating leverage, an increase in sales

produces a relatively larger increase in operating

income.

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Quantity

{

$

Total Revenue

Total Cost= FixedFC

Break-evenpoint

}Q1

+

-

EBIT

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Quantity

{

$

Total Revenue

Total Cost= FixedFC

Break-evenpoint

}Q1

+

-

EBIT

Trade-off: the firm has

a higher breakeven point. If sales are not high enough, the firm will not meet its fixed

expenses!

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Breakeven point (units of output)

QB = breakeven level of Q.F = total anticipated fixed costs.P = sales price per unit.V = variable cost per unit.

Breakeven Calculations

QB = FP - V

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Breakeven point (sales dollars)

S* = breakeven level of sales.F = total anticipated fixed costs.S = total sales.VC = total variable costs.

Breakeven Calculations

S* = F VC S

1 -

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Analytical Income Statement

sales- variable costs- fixed costs operating income- interest EBT- taxes net income

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Degree of Operating Leverage (DOL)

Operating leverage: by using fixed operating costs, a small change in sales revenue is magnified into a larger change in operating income.

This “multiplier effect” is called the degree of operating leverage.

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DOLs = % change in EBIT% change in sales

change in EBIT EBITchange in sales sales

=

Degree of Operating Leveragefrom Sales Level (S)

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If we have the data, we can use this formula:

Degree of Operating Leveragefrom Sales Level (S)

Q(P - V) Q(P - V) - F

=

DOLs = Sales - Variable Costs EBIT

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What does this tell us?

If DOL = 2, then a 1% increase in sales will result in a 2% increase in operating income (EBIT).

Stock-holdersEBIT EPSSales

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Degree of Financial Leverage (DFL)

Financial leverage: by using fixed cost financing, a small change in operating income is magnified into a larger change in earnings per share.

This “multiplier effect” is called the degree of financial leverage.

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DFL = % change in EPS% change in EBIT

change in EPS EPSchange in EBIT EBIT

Degree of Financial Leverage

=

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Degree of Financial Leverage

DFL = EBIT EBIT - I

If we have the data, we can use this formula:

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What does this tell us?

If DFL = 3, then a 1% increase in operating income will result in a 3% increase in earnings per share.

Stock-holdersEBIT EPSSales

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Degree of Combined Leverage (DCL)

Combined leverage: by using operating leverage and financial leverage, a small change in sales is magnified into a larger change in earnings per share.

This “multiplier effect” is called the degree of combined leverage.

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DCL = DOL x DFL

Degree of Combined Leverage

= % change in EPS% change in Sales

change in EPS EPSchange in Sales Sales

=

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Degree of Combined Leverage If we have the data, we can use this formula:

DCL = Sales - Variable Costs EBIT - I

Q(P - V) Q(P - V) - F - I

=

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What does this tell us?

If DCL = 4, then a 1% increase in sales will result in a 4% increase in earnings per share.

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What does this tell us?

If DCL = 4, then a 1% increase in sales will result in a 4% increase in earnings per share.

Stock-holdersEBIT EPSSales

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In-class Project:Based on the following information on

Levered Company, answer these questions:

1) If sales increase by 10%, what should happen to operating income?

2) If operating income increases by 10%, what should happen to EPS?

3) If sales increase by 10%, what should be the effect on EPS?

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Levered Company

Sales (100,000 units)$1,400,000

Variable Costs $800,000Fixed Costs

$250,000Interest paid

$125,000Tax rate

34%Common shares outstanding 100,000

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EPS

Financialleverage

OperatingIncomeSales

Operatingleverage

Levered Company

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Degree of Operating Leverage from Sales Level (S)

1,400,000 - 800,000 350,000

= 1.714

=

DOLs = Sales - Variable Costs EBIT

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EPSOperatingIncomeSales

Operatingleverage

10%17.14%

Levered Company

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Degree of Financial Leverage

DFL = EBIT EBIT - I

= 350,000 225,000

= 1.556

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EPS

Financialleverage

OperatingIncomeSales

10%15.56%

Levered Company

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Degree of Combined Leverage

DCL = Sales - Variable Costs EBIT - I

1,400,000 - 800,000 225,000

= 2.667

=

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EPS

Financialleverage

OperatingIncomeSales

10%26.67%

Operatingleverage

Levered Company

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Sales (110,000 units) 1,540,000 Variable Costs (880,000) Fixed Costs (250,000) EBIT 410,000 ( +17.14%) Interest (125,000) EBT 285,000 Taxes (34%) (96,900) Net Income 188,100 EPS $1.881

( +26.67%)

Levered Company10% increase in sales

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Penutup

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