GE 301

ENGINEERING ECONOMY
CAPITAL FINANCING

Engr. Andrei Michael A. Fonacier, ECE

EQUITY CAPITAL
Equity or ownership capital/funds are those supplied and used
by the owners of an enterprise in the expectation that a profit
will be earned.

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BORROWED CAPITAL
Borrowed capital/fund are those supplied by others on which
a fixed rate of interest must be paid and the debt must be
repaid at a specified time.

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TYPES OF BUSINESS
ORGANIZATIONS
1. SOLE PROPRIETORSHIP
2. PARTNERSHIP
3. CORPORATION

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SOLE PROPRIETORSHIP
Also known as Individual Ownership
It is the simplest form of business organization, wherein a
person uses his or her own capital to establish a business and
is the sole owner.

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SOLE PROPRIETORSHIP
Advantages:
1. It is easy to organize.
2. The owner has full control of the enterprise.
3. The owner is entitled to whatever benefits and profits that
accrue from the business.

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SOLE PROPRIETORSHIP
Disadvantages:
1. The amount of equity capital, which can be accumulated, is
limited.
2. The organization ceases upon the death of the owner.
3. It is difficult to obtain borrowed capital, owing to the
uncertainty of the life of the organization.
4. The liability of the owner for his debts is unlimited.
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PARTNERSHIP
It is an association of two or more persons for the purpose of
engaging in a business for profit.

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PARTNERSHIP
Advantages:
1. More capital may be obtained by the partners pooling their
resources together.
2. It is bound by few legal requirements as it to its accounts,
procedures, tax forms, and other items of operation.

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PARTNERSHIP
Advantages:
1. More capital may be obtained by the partners pooling their
resources together.
2. It is bound by few legal requirements as it to its accounts,
procedures, tax forms, and other items of operation.
3. Dissolution of the partnership may take place at any time
by mere agreement of the partners.
4. It provides an easy method whereby two or more persons
of differing talents may enter into business, each carrying
those burdens that he can best handle.
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PARTNERSHIP
Disadvantages:
1. The amount of capital that can be accumulated is definitely
limited.
2. The life of the partnership is determined by the life of the
individual partners. When any other partner dies, the
partnership automatically ends.
3. There may be serious disagreements among the individual
partners.
4. Each partner is liable for the debts of the partnership.
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CORPORATION
It is a distinct legal entity, separate from the individuals who
own it, and which can engage in almost any type of business
transaction in which a real person could occupy himself or
herself.

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CORPORATION
Advantages
1. It enjoys perpetual life without regard to any change in the
person of its owners, the stockholders.
2. The stockholders of the corporation are not liable for the
debts of the corporation.
3. It is relatively easier to obtain large amounts of money for
expansion, due to its perpetual life.
4. The ownership in the corporation is readily transferred.
5. Authority is easily delegated by the hiring of managers.
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CORPORATION
Disadvantages
1. The activities of a corporation are limited to those stated in
its charter.
2. It is relatively complicated in formation and administration.
3. There is a greater degree of governmental control as
compared to other types of business organizations.

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CAPITALIZATION OF A
CORPORATION
It is acquired through the sale of stock.

There are two principal types of capital stock:

1. COMMON STOCK
2. PREFERRED STOCK

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COMMON STOCK
It represents ordinary ownership without special guarantees
of return.

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COMMON STOCK
Common Stockholders Legal Rights:
1. Vote at stockholders meeting
2. Elect directors and delegates to them power to conduct the
affairs of the business
3. Sell or dissolve the corporation
4. Make and amend the laws of the corporation
5. Subject to government approval, amend, or change the charter
of the capital structure
6. Participate in the profits
7. Inspect the books of the corporation
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PREFERRED STOCK
Preferred stockholders are guaranteed a definite dividend on
their stocks.
In case the corporation is dissolved, the assets must be used
to satisfy the claims of the preferred stockholders before
those of the holders of the common stock
Preferred stockholders usually do not have the right to vote in
meetings, but not always.
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FINANCING WITH BONDS

BOND
A bond is a certificate of indebtedness of a corporation usually
for a period not less than ten years and guaranteed by a
mortgage on certain assets of the corporation or its
subsidiaries.
Bonds are issued when there is need for more capital such as
for expansion of the plant or the services rendered by the
corporation.
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BOND
FACE VALUE is the money amount the bond will be worth at
its maturity, and is also the reference amount the bond issuer
uses when calculating interest payments.
COUPON RATE is the rate of interest the bond issuer will pay
on the face value of the bond, expressed as a percentage.

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BOND
COUPON DATES are the dates on which the bond issuer will
make interest payments. Typical intervals are annual or semiannual coupon payments.
MATURITY DATE is the date on which the bond will mature
and the bond issuer will pay the bond holder the face value of
the bond.

ISSUE PRICE is the price at which the bond issuer originally

sells the bonds.
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BOND
CATEGORIES OF BONDS:
1. Corporate Bonds issued by companies
2. Municipal Bonds issued by states and municipalities
3. Treasury Bonds for more than 10years to mature
4. Notes 1-10years to mature
5. Bills less than one year to mature

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BOND
CLASSIFICATION OF BONDS
1. Registered bonds
2. Coupon Bonds

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REGISTERED BONDS
The name of the owner of this bond is recorded on the record
books of the corporation and interest payments are sent to
the owner periodically without any action on his part.

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COUPON BONDS
They have coupon attached to the bond for each interest
payment that will come due during the life of the bond. The
owner of the bond can collect the interest due by
surrendering the coupon to the offices of the corporation or at
specified banks.

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METHODS OF BOND RETIREMENT

1. The corporation may issue another set of bonds equal to
the amount of bonds due for redemption.

2. The corporation may set up a sinking fund into which

periodic deposits of equal amount are made. The
accumulated amount in the sinking fund is equal to the
amount needed to retire the bonds at the time they are
due.
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BOND RETIREMENT BY SINKING

FUND
=
=
=
=
=
+ =

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BOND RETIREMENT BY SINKING

FUND
= , %,
=

1+ 1

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BOND RETIREMENT BY SINKING

FUND

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EXAMPLE M7.1
A bond issue of P200,000 in 10-year bonds paying 16%
nominal interest in semiannual payments, must be retired by
the use of a sinking fund that earns 12% compounded
semiannually. What is the total semiannual expense?
SOLUTION:

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SOLUTION:
= 200,000
0.16
2

=
= 0.08
=
= 200,000 0.08 = 16,000

1+ 1

= 200,000

0.12
2
0.12 210
1+ 2
1

= 5,436.91
= 16,000 + 5,436.92
= 21,436.92

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BOND VALUE
It is the present worth of all future amounts that are expected
to be received through ownership of the bond.
= ,
= ( )
=
=
=
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BOND VALUE

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EXAMPLE M7.2
A man wishes to make 14% nominal interest compounded
semiannually on a bond investment. How much should the
man be willing to pay now for a 12%, P10,000-bond that will
mature in 10 years and pays interest semiannually?
SOLUTION:

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SOLUTION:
= 10,000
= 1 +
1 = 10,000 1 +

2 = 600
0.14 210
2

1 = 2,584.19
=
=

0.12
2

0.14 210
1+
2
0.14
2

2 = 6,356.41
= 1 + 2
= 2,584.19 + 6,356.41
= 8,940.60

= 0.06

= 10,000 0.06 = 600

1 1+

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EXAMPLE M7.3
A P1,000-bond which will mature in 10 years and with a bond
rate of 8% payable annually is to be redeemed at par at the
end of this period. If it is sold now for P1,030, determine the
yield at this price.
SOLUTION:

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SOLUTION:
= 1,000
= 1,030
= 0.08
=
= 1,000 0.08 = 80
= 1 +
1 = 1,000 1 + 10
1 1+
=

1 1+ 10
2 = 80

= 1 + 2
1,030 = 1,000 1 +
1 1+ 10
80

10

solve for i:
= 0.0756
= 7.56%

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EXAMPLE M7.4
A corporation sold an issue of 20-year bonds, having a total
face value of P10,000,000 for P9,500,000. The bonds bear
interest at 16%, payable semiannually. The company wishes
to establish a sinking fund for tiring the bond issue and will
make semiannual deposits that will earn 12%, compounded
semiannually. Compute the annual cost of this bond.

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SOLUTION:
SEMI-ANNUALLY

ANNUALLY

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SOLUTION:
= 10,000,000
=

0.16
2

= 0.08

1+

=
= 10,000,000 0.08
= 800,000
=

1+

1 = 800,000

= 123,809,572.50 + 10,000,000
= 133,809,572.50

0.12 220
1+
1
2
0.12
2

1 = 123,809,572.50
= 1 + 10,000,000

1+

2
2
0.12 2

1
= 1+1
1
1+1

= 0.1236
=

1+ 1

133809572.5 =

1+0.1236 20 1
0.1236

= 1,781,107.64
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EXAMPLE M7.5
A company has issued 10-year bonds, with face value of
P100,000 in 1,000 units. Interest at 16% is aid quarterly. If an
investor desires to earn 20% compounded quarterly, what
would the selling price have to be?
SOLUTION:

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 = 1+

SOLUTION:
= 100,000
=

0.16
4

2 = 100,000 1 +

= 0.04

0.2 410
4

2 = 14,204.57
=
= 1 + 2
= 100,000 0.04 = 4,000 = 68,636.35 + 14,204.57
1 1+
= 82,840.92
=

1 = 4,000

0.20 410
1+
4
0.20
4

1 = 68,636.35
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REVIEW PROBLEMS
RPM6.1 The cost of equipment is P500,000 and the cost of
installation is P30,000. If the salvage value is 10% of the cost
of equipment only at the end of 5 years, determine the book
value at the end of the fourth year. Use straight line method.

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REVIEW PROBLEMS
RPM6.2 An engineer bought an equipment for P500,000. He
spent an additional amount of P30,000 for installation and
other expenses. The salvage value is 10% of the first cost. If
the book value at the end of 5 years will be P291,500 using
straight line method of depreciation, compute the useful life
of the equipment in years.

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REVIEW PROBLEMS
RPM6.3 A broadcasting corporation is purchased equipment
for P53,000 and paid P1,500 for freight and delivery charges to
the job site. The equipment has a normal life of 10 years with
a trade-in value of P5,000 against the purchase of a new
equipment at the end of the life. If the corporation is
investing, which is equal to the depreciation using sinking
fund, to a bank having a rate of 6%, what will be annual
investment of the firm?

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REVIEW PROBLEMS
RPM6.4 A machine cost P7,350 has a life of 8 years and has a
salvage value of P350 at the end of 8 years. Determine its
book value at the end of 4 years using constant-percentage of
declining value.

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REVIEW PROBLEMS
RPM6.5 An equipment costs P500,000 and has a salvage value
of P25,000 after its 25 years of useful life. Using double
declining balanced method, what will be the book value of the
equipment at the end of 8 years?

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REVIEW PROBLEMS
RPM6.6 A company owns an equipment costing P90,000. After
8 years it will have estimated salvage value of P18,000.
compute for the book value at the end of 5 years using SYDM.
(i=0.06)

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REVIEW PROBLEMS
RPM6.7 A machine costs P300,000 with a salvage value of
P15,000 is expected to last for 28,500 hours in a period of 5
years. In the first year of service, it was used for 8000 hours.
Compute for the book value at the end of the first year.

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REVIEW PROBLEMS
RPM6.8 Mr. ABC bought a bond having a face value of P2,000
for P2500. The bond rate was 12% nominal and interest
payments were made to him quarterly for a total of 5 years. At
the end of the fifth year, he sold the bond to a friend at a price
that resulted a yield of 9% nominal on his investment. What
was the selling price?

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