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Introduction
LT Capital Management refers to the management of firms long term investments (assets) and the sources of funding or financing these investments (assets) Long term investment also known as capital budgeting Long term sources of financing the capital budgeting is called long term capital
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Long-term Capital
Long-term capital is sources of financing to fund companys longterm investments or fixed assets. The term capital denotes the longterm funds of a firm. There are two types of capital:
debt capital and equity capital.
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Long-term Financing
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Debt/Bonds Financing
Long-term Financing
Long-term Financing
1. Voice in Management
Debt
creditors to the firm no voting rights, only when firm violated its stated contractual obligations to them.
Equity
owners of the firm voting rights to select the board of directors voting on special issues.
Long-term Financing
Equity
last claims on income i.e. after of all creditors have been satisfied last claims on proceeds of sale of assets if firm fails
Long-term Financing
3. Maturity
Debt
has fixed maturity period require repayment of principal on maturity
Equity
permanent form of financing does not require repayment of principal liquidated only during bankruptcy proceedings.
Long-term Financing
4. Tax Treatment
Debt
interest payments are tax-deductible tax deduction expenses will lower the firms taxes thus, cost of debt financing is lower
Equity
dividends payments are not tax-deductible thus, firms taxes are not lower therefore, cost of equity financing is higher
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1. Equity Financing
Equities are sold (issued) by a company either: 1. at the formation of the company 2. when additional financing are needed. Equities are issued in the Primary Market by the company and resold by the Equities holders in the Secondary Market.
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A. Common Stock
Features of Common Stock
represents ownership, the holders are the true owner of the company no maturity date, but exists as long as the company does stockholders have the residual claim on the firms income and assets
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B. Preferred/Preference Stock
Features of Preferred Stock
a hybrid of common stock and bond. has no maturity date has a par value of usually RM100 per share stockholders receive fixed amount of dividends every year
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2. Debt/Bonds Financing
Features of Debt/Bonds
debt/bond is a long-term debt instrument issued by a firm holders are promised a fixed amount of interest every year until maturity period interest rate also known as coupon rate and thus interest amount is calculated as the coupon rate percentage of the par value par value or face value of bond is normally RM 1000
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Where
= cost of common stock = expected dividend = market price of stock = constant growth in dividend
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Where = risk free return = beta coefficient = market return Note: market return risk free return = market risk premium
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Continuing with the previous example, how much would it cost the firm to raise new equity if flotation costs amount to $4.00 per share? = [$2.75/($50.00 - $4.00)] + .10 = 15.97 %
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Note: Net Proceed = Market Price Flotation Cost Duchess Corporation is contemplating the issuance of a 10% preferred stock that is expected to sell for its $87-per share value. The cost of issuing and selling the stock is expected to be $5 per share. The dividend is $8.70 (10% x $87). The net proceeds price (Np) is $82 ($87 - $5).
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1. Using Cost Quotations; that is based the cost on: a.) our quotation of cost or
b.) cost of similar risk bond a. When the net proceeds (MP FC) from the sale of a bond equal its par value, the before-tax cost equals the coupon interest rate.
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Find the after-tax cost of debt for Duchess assuming it has a 40% tax rate: = 9.4% (1-.40) = 5.6% This suggests that the after-tax cost of raising debt capital for Duchess is 5.6%.
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WACC Equation
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common.
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