Unit 8 Journal

FIN 6301, Corporate Finance 1

Course Learning Outcomes for Unit VIII At the end of this unit, you should be able to:

1. Interpret financial statements to assess a company’s financial performance. 1.3 Analyze a company’s financial statements to assess implications of tactical financing decisions.

5. Recommend financial planning techniques to determine corporate value.

5.6 Utilize financial planning techniques to propose alternative financing strategies. 5.7 Assess the potential impact of financing strategies on corporate value.

Required Unit Resources Chapter 18: Public and Private Financing: Initial Offerings, Seasoned Offerings, and Investment Banks (ULO 1.3) You are not required to read the Summary, Questions, or Web Extension at the end of the chapter. The purpose of this chapter is to understand public and private financing. First, we outline the financial life cycle of a start-up company. We list advantages and disadvantages of going public and explain the steps in going public with an initial public offering (IPO). Next, we measure direct costs and indirect costs of going public and define equity carve-outs. Finally, we will contrast IPOs with other ways to raise funds in capital markets, discuss investment banking activities, and show the role private equity firms play in taking a public company private. Chapter 19: Lease Financing (ULO 1.3) You are not required to read the Summary, Questions, or Web Extension at the end of the chapter. The purpose of this chapter is to understand lease financing. First, we will name the different types of leases and list the steps in reporting leases on financial statements. Next, we will identify criteria used by the IRS to determine the tax status of a lease and determine the net advantage of leasing (NAL) for a nontax-oriented lease. Finally, we will evaluate a lease from the lessor’s viewpoint, show how the 2017 TCJA affected leases, and discuss reasons for leasing other than tax advantages. Chapter 20: Hybrid Financing: Preferred Stock, Warrants, and Convertibles (ULOs 5.6 and 5.7) You are not required to read the Summary, Questions, or Web Extension at the end of the chapter. The purpose of this chapter is to understand hybrid financing. First, we will evaluate the relative risks of preferred stock, debt, and common equity. We will name some features of preferred stock as well as advantages and disadvantages of preferred stock. Next, we will show how warrants are used in financing, determine the pre-tax cost of capital for bonds and warrants, and utilize conversion ratios and conversion prices. Finally, we will discuss the effect of convertibles and agency costs, contrast warrants and convertible debt, and explain how to report diluted earnings per share.

Unit Lesson Lesson: Understanding Corporate Financing: IPOs, Leases, and Hybrids (ULOs 1.3 and 5.6) In today's ever-evolving financial landscape, understanding the intricacies of corporate financing is paramount. Delve into the multifaceted world of public offerings, leasing dynamics, and innovative hybrid securities, gaining invaluable insights to navigate and strategize in the corporate finance realm effectively.

UNIT VIII STUDY GUIDE

Tactical Financing Decisions

FIN 6301, Corporate Finance 2

UNIT x STUDY GUIDE

Title

Public and Private Financing: Initial Offerings, Seasoned Offerings, and Investment Banks The Financial Life Cycle of a Start-up Company Every company embarks on a journey reminiscent of life itself, facing challenges, milestones, and pivotal moments that shape its trajectory. This journey can be visualized as a curve, starting with the birth of an idea, and moving through phases of growth, maturity, and potentially, rejuvenation or decline.

• Seed stage: This is where it all begins. A founder has an idea and starts a business, often bootstrapping or using their personal savings. The risks are high, and the business model might still be in its prototype phase.

• Start-up stage: With a proof of concept in hand, external funding sources such as angel investors or early-stage venture capitalists become potential stakeholders. This funding is crucial to scale the operations and hire a team.

• Growth and establishment stage: As the company starts generating steady revenue, it may attract larger venture capital rounds or even contemplate an initial public offering (IPO). This is the stage where firms like Amazon transitioned from being a promising venture to a dominant market player.

Going Public: Pros and Cons When a company reaches a certain stature and has a predictable revenue model, it might consider going public. This decision, however, is multifaceted. Advantages can include market credibility—being publicly listed can enhance a company's reputation and visibility in the market. Another advantage is employee benefits because stock options become a viable incentive for attracting top talent. Disadvantages can include reporting pressure because quarterly reporting can force companies to be short- term focused. Another possible disadvantage is vulnerability to market fluctuations. The company's stock price can be influenced by market conditions beyond its control. Costs of Going Public Going public is an expensive affair. Companies need to be aware that the influx of capital comes at a price. Direct costs are relatively straightforward—fees paid to investment bankers, legal teams, and for promotional events leading up to the IPO. Indirect costs can be trickier to quantify. They can include potential hits to the company’s image if the IPO does not go as planned, the opportunity cost of the time senior management invests in the process, and potential changes in company culture post-IPO. Equity Carve-Outs and Alternatives to IPOs Not all companies choose the IPO route. There are several alternatives:

FIN 6301, Corporate Finance 3

UNIT x STUDY GUIDE

Title

Investment Banking and Private Equity These entities are the gatekeepers and facilitators of the financial world. Investment banks serve as intermediaries, helping companies navigate the complex process of going public, from valuation to ensuring regulatory compliance. Private equity firms see value where others do not. They might buy out public companies, streamline operations, and potentially relist them. Their modus operandi is to extract maximum value from their investments, sometimes leading to industry transformation. As companies evolve, so do their financing needs. The choice of how and when to secure funds is a strategic one, influencing not just the company’s balance sheet, but its very ethos and future trajectory.

Lease Financing Leases are versatile financial instruments, allowing businesses to access assets without direct ownership. While there are many ways to categorize leases, the most common distinction is between operating and capital (or finance) leases. Operating leases are often used for short-term needs and do not transfer ownership of the asset. The lessee simply pays for the use of the asset, and at the end of the lease term, returns it. This can be compared to renting an apartment. Capital (finance) leases are more long-term in nature and are structured so that the lessee assumes most benefits and risks associated with ownership. By the end of the lease term, the lessee might have the option to purchase the asset. Think of it as a car lease where you might buy the vehicle at the end. Reporting Leases on Financial Statements Financial transparency is a cornerstone of modern business. Therefore, the way companies report leases is of paramount importance:

FIN 6301, Corporate Finance 4

UNIT x STUDY GUIDE

Title

Tax Status and Net Advantage of Leasing (NAL) Leasing is not just about accessing assets; it is a strategic decision influenced by various financial implications, one of which is tax implications. Depending on how a lease is structured and classified, there can be differing tax benefits. For instance, lease payments under an operating lease are often deductible as a business expense. Another implication is the net advantage of leasing (NAL): This is a comprehensive metric that weighs the pros and cons of leasing against purchasing. Factors considered include initial costs, monthly payments, tax implications, and residual value. 2017 TCJA and Its Impact on Leases Taxation can be a game-changer in financial decision-making. The Tax Cuts and Jobs Act of 2017 (TCJA) was one such pivotal moment. One change resulting from the act involved interest limitations. The TCJA introduced new limits on the deductibility of business interest, potentially impacting the attractiveness of lease financing. Another change involved alteration in deductions. Changes in how businesses could deduct expenses related to tangible property influenced leasing decisions, especially for companies heavily reliant on physical assets. In essence, leasing is a flexible tool in a company’s financial toolkit, enabling them to strategically manage their assets, liabilities, and tax obligations. Like all tools, its effectiveness depends on the adeptness with which it is used in a given situation.

Hybrid Financing: Preferred Stock, Warrants, and Convertibles The Complexity of Preferred Stock At its core, preferred stock is a unique blend of debt and equity representing ownership in a company but with a priority claim on dividends and assets. Unlike common stockholders, preferred stockholders receive dividends before any are distributed to common stockholders. However, the dividends are typically fixed, much like interest payments on a debt. Preferred stock carries less risk than common stock but also usually offers less potential for appreciation. It sits in between debt and common equity in the capital structure. For companies, they can be an efficient way to raise capital without diluting common equity or taking on debt obligations.

FIN 6301, Corporate Finance 5

UNIT x STUDY GUIDE

Title

The Role of Warrants in Financing In essence, warrants are like options, providing the right but not the obligation to buy shares at a predetermined price. Warrants add utility in fundraising; when companies issue bonds, adding warrants can enhance their attractiveness. This strategy often appeals to investors who seek potential equity upside while still having the safety of a bond. The value of a warrant depends on various factors like the underlying stock price, volatility, and time to expiration. They can be traded separately from their associated bonds, offering a liquidity advantage. Convertibles and Their Impact Convertible securities, be it bonds or preferred stock, offer a middle ground, blending the characteristics of debt and equity.

• Advantages to issuers: Convertibles often carry lower interest or dividend rates than their nonconvertible counterparts because they offer the possibility of conversion to common stock. This can be advantageous for companies in sectors like tech, where equity appreciation potential is high.

• Advantages to investors: Convertibles provide a sort of safety net. If the company does well and its stock price rises, they can convert their securities to common stock, capturing the upside. If the stock does not perform, they still receive the bond's interest or the preferred stock’s dividend.

• Dilution concerns: One potential downside for existing shareholders is the dilution of their equity when convertibles are converted into common stock. However, this typically happens when the stock is performing well, so the dilution comes at a time of upward price movement.

In the vast spectrum of financial instruments, hybrid securities like preferred stock, warrants, and convertibles offer both challenges and opportunities. They exemplify the innovative ways in which companies can raise capital while providing investors with a range of risk and reward profiles.

Reference Naranjo, P., Saavedra, D., & Verdi, R. S. (2022, October). The pecking order and financing decisions:

Evidence from changes to financial-reporting regulation. Journal of Accounting, Auditing & Finance, 37(4), 727–750. https://libraryresources.columbiasouthern.edu/login?url=https://search.ebscohost.com/login.aspx?dire ct=true&db=bsu&AN=158631326&site=ehost-live&scope=site

Suggested Unit Resources Article: The Pecking Order and Financing Decisions: Evidence From Changes to Financial- Reporting Regulation (Optional) This article looks at the importance of pecking order theory in relation to financial-reporting regulation and making financing decisions (24 pages).

FIN 6301, Corporate Finance 1

Course Learning Outcomes for Unit VIII At the end of this unit, you should be able to:

1. Interpret financial statements to assess a company’s financial performance. 1.3 Analyze a company’s financial statements to assess implications of tactical financing decisions.

5. Recommend financial planning techniques to determine corporate value.

5.6 Utilize financial planning techniques to propose alternative financing strategies. 5.7 Assess the potential impact of financing strategies on corporate value.

Required Unit Resources Chapter 18: Public and Private Financing: Initial Offerings, Seasoned Offerings, and Investment Banks (ULO 1.3) You are not required to read the Summary, Questions, or Web Extension at the end of the chapter. The purpose of this chapter is to understand public and private financing. First, we outline the financial life cycle of a start-up company. We list advantages and disadvantages of going public and explain the steps in going public with an initial public offering (IPO). Next, we measure direct costs and indirect costs of going public and define equity carve-outs. Finally, we will contrast IPOs with other ways to raise funds in capital markets, discuss investment banking activities, and show the role private equity firms play in taking a public company private. Chapter 19: Lease Financing (ULO 1.3) You are not required to read the Summary, Questions, or Web Extension at the end of the chapter. The purpose of this chapter is to understand lease financing. First, we will name the different types of leases and list the steps in reporting leases on financial statements. Next, we will identify criteria used by the IRS to determine the tax status of a lease and determine the net advantage of leasing (NAL) for a nontax-oriented lease. Finally, we will evaluate a lease from the lessor’s viewpoint, show how the 2017 TCJA affected leases, and discuss reasons for leasing other than tax advantages. Chapter 20: Hybrid Financing: Preferred Stock, Warrants, and Convertibles (ULOs 5.6 and 5.7) You are not required to read the Summary, Questions, or Web Extension at the end of the chapter. The purpose of this chapter is to understand hybrid financing. First, we will evaluate the relative risks of preferred stock, debt, and common equity. We will name some features of preferred stock as well as advantages and disadvantages of preferred stock. Next, we will show how warrants are used in financing, determine the pre-tax cost of capital for bonds and warrants, and utilize conversion ratios and conversion prices. Finally, we will discuss the effect of convertibles and agency costs, contrast warrants and convertible debt, and explain how to report diluted earnings per share.

Unit Lesson Lesson: Understanding Corporate Financing: IPOs, Leases, and Hybrids (ULOs 1.3 and 5.6) In today's ever-evolving financial landscape, understanding the intricacies of corporate financing is paramount. Delve into the multifaceted world of public offerings, leasing dynamics, and innovative hybrid securities, gaining invaluable insights to navigate and strategize in the corporate finance realm effectively.

UNIT VIII STUDY GUIDE

Tactical Financing Decisions

FIN 6301, Corporate Finance 2

UNIT x STUDY GUIDE

Title

Public and Private Financing: Initial Offerings, Seasoned Offerings, and Investment Banks The Financial Life Cycle of a Start-up Company Every company embarks on a journey reminiscent of life itself, facing challenges, milestones, and pivotal moments that shape its trajectory. This journey can be visualized as a curve, starting with the birth of an idea, and moving through phases of growth, maturity, and potentially, rejuvenation or decline.

• Seed stage: This is where it all begins. A founder has an idea and starts a business, often bootstrapping or using their personal savings. The risks are high, and the business model might still be in its prototype phase.

• Start-up stage: With a proof of concept in hand, external funding sources such as angel investors or early-stage venture capitalists become potential stakeholders. This funding is crucial to scale the operations and hire a team.

• Growth and establishment stage: As the company starts generating steady revenue, it may attract larger venture capital rounds or even contemplate an initial public offering (IPO). This is the stage where firms like Amazon transitioned from being a promising venture to a dominant market player.

Going Public: Pros and Cons When a company reaches a certain stature and has a predictable revenue model, it might consider going public. This decision, however, is multifaceted. Advantages can include market credibility—being publicly listed can enhance a company's reputation and visibility in the market. Another advantage is employee benefits because stock options become a viable incentive for attracting top talent. Disadvantages can include reporting pressure because quarterly reporting can force companies to be short- term focused. Another possible disadvantage is vulnerability to market fluctuations. The company's stock price can be influenced by market conditions beyond its control. Costs of Going Public Going public is an expensive affair. Companies need to be aware that the influx of capital comes at a price. Direct costs are relatively straightforward—fees paid to investment bankers, legal teams, and for promotional events leading up to the IPO. Indirect costs can be trickier to quantify. They can include potential hits to the company’s image if the IPO does not go as planned, the opportunity cost of the time senior management invests in the process, and potential changes in company culture post-IPO. Equity Carve-Outs and Alternatives to IPOs Not all companies choose the IPO route. There are several alternatives:

FIN 6301, Corporate Finance 3

UNIT x STUDY GUIDE

Title

Investment Banking and Private Equity These entities are the gatekeepers and facilitators of the financial world. Investment banks serve as intermediaries, helping companies navigate the complex process of going public, from valuation to ensuring regulatory compliance. Private equity firms see value where others do not. They might buy out public companies, streamline operations, and potentially relist them. Their modus operandi is to extract maximum value from their investments, sometimes leading to industry transformation. As companies evolve, so do their financing needs. The choice of how and when to secure funds is a strategic one, influencing not just the company’s balance sheet, but its very ethos and future trajectory.

Lease Financing Leases are versatile financial instruments, allowing businesses to access assets without direct ownership. While there are many ways to categorize leases, the most common distinction is between operating and capital (or finance) leases. Operating leases are often used for short-term needs and do not transfer ownership of the asset. The lessee simply pays for the use of the asset, and at the end of the lease term, returns it. This can be compared to renting an apartment. Capital (finance) leases are more long-term in nature and are structured so that the lessee assumes most benefits and risks associated with ownership. By the end of the lease term, the lessee might have the option to purchase the asset. Think of it as a car lease where you might buy the vehicle at the end. Reporting Leases on Financial Statements Financial transparency is a cornerstone of modern business. Therefore, the way companies report leases is of paramount importance:

FIN 6301, Corporate Finance 4

UNIT x STUDY GUIDE

Title

Tax Status and Net Advantage of Leasing (NAL) Leasing is not just about accessing assets; it is a strategic decision influenced by various financial implications, one of which is tax implications. Depending on how a lease is structured and classified, there can be differing tax benefits. For instance, lease payments under an operating lease are often deductible as a business expense. Another implication is the net advantage of leasing (NAL): This is a comprehensive metric that weighs the pros and cons of leasing against purchasing. Factors considered include initial costs, monthly payments, tax implications, and residual value. 2017 TCJA and Its Impact on Leases Taxation can be a game-changer in financial decision-making. The Tax Cuts and Jobs Act of 2017 (TCJA) was one such pivotal moment. One change resulting from the act involved interest limitations. The TCJA introduced new limits on the deductibility of business interest, potentially impacting the attractiveness of lease financing. Another change involved alteration in deductions. Changes in how businesses could deduct expenses related to tangible property influenced leasing decisions, especially for companies heavily reliant on physical assets. In essence, leasing is a flexible tool in a company’s financial toolkit, enabling them to strategically manage their assets, liabilities, and tax obligations. Like all tools, its effectiveness depends on the adeptness with which it is used in a given situation.

Hybrid Financing: Preferred Stock, Warrants, and Convertibles The Complexity of Preferred Stock At its core, preferred stock is a unique blend of debt and equity representing ownership in a company but with a priority claim on dividends and assets. Unlike common stockholders, preferred stockholders receive dividends before any are distributed to common stockholders. However, the dividends are typically fixed, much like interest payments on a debt. Preferred stock carries less risk than common stock but also usually offers less potential for appreciation. It sits in between debt and common equity in the capital structure. For companies, they can be an efficient way to raise capital without diluting common equity or taking on debt obligations.

FIN 6301, Corporate Finance 5

UNIT x STUDY GUIDE

Title

The Role of Warrants in Financing In essence, warrants are like options, providing the right but not the obligation to buy shares at a predetermined price. Warrants add utility in fundraising; when companies issue bonds, adding warrants can enhance their attractiveness. This strategy often appeals to investors who seek potential equity upside while still having the safety of a bond. The value of a warrant depends on various factors like the underlying stock price, volatility, and time to expiration. They can be traded separately from their associated bonds, offering a liquidity advantage. Convertibles and Their Impact Convertible securities, be it bonds or preferred stock, offer a middle ground, blending the characteristics of debt and equity.

• Advantages to issuers: Convertibles often carry lower interest or dividend rates than their nonconvertible counterparts because they offer the possibility of conversion to common stock. This can be advantageous for companies in sectors like tech, where equity appreciation potential is high.

• Advantages to investors: Convertibles provide a sort of safety net. If the company does well and its stock price rises, they can convert their securities to common stock, capturing the upside. If the stock does not perform, they still receive the bond's interest or the preferred stock’s dividend.

• Dilution concerns: One potential downside for existing shareholders is the dilution of their equity when convertibles are converted into common stock. However, this typically happens when the stock is performing well, so the dilution comes at a time of upward price movement.

In the vast spectrum of financial instruments, hybrid securities like preferred stock, warrants, and convertibles offer both challenges and opportunities. They exemplify the innovative ways in which companies can raise capital while providing investors with a range of risk and reward profiles.

Reference Naranjo, P., Saavedra, D., & Verdi, R. S. (2022, October). The pecking order and financing decisions:

Evidence from changes to financial-reporting regulation. Journal of Accounting, Auditing & Finance, 37(4), 727–750. https://libraryresources.columbiasouthern.edu/login?url=https://search.ebscohost.com/login.aspx?dire ct=true&db=bsu&AN=158631326&site=ehost-live&scope=site

Suggested Unit Resources Article: The Pecking Order and Financing Decisions: Evidence From Changes to Financial- Reporting Regulation (Optional) This article looks at the importance of pecking order theory in relation to financial-reporting regulation and making financing decisions (24 pages).