Download Hypothetical - E-Commerce - Lecture Slides and more Slides Fundamentals of E-Commerce in PDF only on Docsity!
What managers consider important in deciding
on how much debt to carry...
¨ A survey of Chief Financial Officers of large U.S.
companies provided the following ranking (from most
important to least important) for the factors that they
considered important in the financing decisions
Factor Ranking (0-‐5)
- Maintain financial flexibility 4.
- Ensure long-‐term survival 4.
- Maintain Predictable Source of Funds 4.
- Maximize Stock Price 3.
- Maintain financial independence 3.
- Maintain high debt raUng 3.
- Maintain comparability with peer group 2.
Debt: Summarizing the trade off
ApplicaUon Test: Would you expect your firm to
gain or lose from using a lot of debt?
¨ Considering, for your firm,
¤ The potenUal tax benefits of borrowing
¤ The benefits of using debt as a disciplinary mechanism
¤ The potenUal for expected bankruptcy costs
¤ The potenUal for agency costs
¤ The need for financial flexibility
¨ Would you expect your firm to have a high debt
raUo or a low debt raUo?
¨ Does the firm’s current debt raUo meet your
expectaUons?
A HypotheUcal Scenario
Assume that you live in a world where
(a) There are no taxes
(b) Managers have stockholder interests at heart and do
what’s best for stockholders.
(c) No firm ever goes bankrupt
(d) Equity investors are honest with lenders; there is no
subterfuge or aSempt to find loopholes in loan agreements.
(e) Firms know their future financing needs with certainty
¨ What happens to the trade off between debt and
equity? How much should a firm borrow?
What do firms look at in financing?
¨ There are some who argue that firms follow a financing
hierarchy, with retained earnings being the most
preferred choice for financing, followed by debt and that
new equity is the least preferred choice. In parUcular,
¤ Managers value flexibility. Managers value being able to use
capital (on new investments or assets) without restricUons on
that use or having to explain its use to others.
¤ Managers value control. Managers like being able to maintain
control of their businesses.
¨ With flexibility and control being key factors:
¤ Would you rather use internal financing (retained earnings) or
external financing?
¤ With external financing, would you rather use debt or equity?
Preference rankings long-‐term finance: Results
of a survey
Ranking Source Score
1 Retained Earnings^ 5.
2 Straight Debt^ 4.
3 Convertible Debt^ 3.
4 External Common Equity^ 2.
5 Straight Preferred Stock^ 2.
6 Convertible Preferred^ 1.
Financing Choices
¨ You are reading the Wall Street Journal and noUce a
tombstone ad for a company, offering to sell
converUble preferred stock. What would you
hypothesize about the health of the company issuing
these securiUes?
a. Nothing
b. Healthier than the average firm
c. In much more financial trouble than the average
firm
