Corporate Finance

🗃️Corporate Finance Unit 10 – Long–Term Financing

Long-term financing is crucial for companies to fund major projects and acquire assets. It involves financial obligations extending beyond one year, impacting a company's capital structure and stability. Companies use it to invest in growth, maintain liquidity, and stay competitive. Various options exist, including debt financing like bonds and loans, equity financing through stocks, and hybrid securities. Each has pros and cons, affecting ownership control, financial leverage, and cost of capital. Choosing the right mix requires careful analysis of a company's needs and goals.

What's Long-Term Financing?

  • Refers to financial obligations and investments that extend beyond one year
  • Typically used for major capital expenditures (purchasing equipment, expanding facilities)
  • Helps companies acquire assets, invest in growth opportunities, and fund long-term projects
  • Differs from short-term financing focuses on meeting immediate cash flow needs and operational expenses
  • Long-term financing decisions impact a company's capital structure, financial leverage, and overall financial stability
  • Requires careful planning and analysis to ensure the company can meet its long-term financial commitments
  • Involves a variety of financing options (debt, equity) tailored to the company's specific needs and goals

Why Companies Need It

  • Fund capital-intensive projects (research and development, business expansion) that require significant upfront investment
  • Acquire long-term assets (real estate, machinery) essential for business operations and growth
  • Maintain a balanced capital structure by optimizing the mix of debt and equity financing
  • Ensure sufficient liquidity to meet long-term financial obligations and withstand economic downturns
  • Take advantage of growth opportunities (mergers and acquisitions) that require substantial capital
  • Invest in infrastructure, technology, and human capital to enhance competitiveness and profitability
  • Smooth out cash flow fluctuations and provide a stable source of funds for ongoing operations

Types of Long-Term Financing

  • Long-term debt financing
    • Bonds: Fixed-income securities issued by companies to borrow funds from investors
    • Bank loans: Secured or unsecured loans provided by financial institutions with specific repayment terms
    • Leasing: Acquiring the use of an asset (equipment) through a long-term rental agreement
  • Equity financing
    • Common stock: Selling ownership shares in the company to investors in exchange for capital
    • Preferred stock: Hybrid security combining features of debt and equity, with priority over common stockholders
    • Retained earnings: Reinvesting profits generated by the company into its operations and growth
  • Hybrid securities
    • Convertible bonds: Debt instruments that can be converted into a predetermined number of common stock shares
    • Warrants: Options issued by a company allowing investors to purchase its stock at a specific price within a set timeframe

Pros and Cons of Different Options

  • Long-term debt financing
    • Pros: Tax-deductible interest payments, maintains ownership control, fixed repayment terms
    • Cons: Increased financial leverage, default risk, restrictive covenants
  • Equity financing
    • Pros: No fixed repayment obligations, enhances creditworthiness, allows for risk-sharing with investors
    • Cons: Dilution of ownership, potential loss of control, higher cost of capital compared to debt
  • Hybrid securities
    • Pros: Flexibility for investors, lower coupon rates compared to traditional bonds, potential for equity upside
    • Cons: Complexity, dilution of ownership upon conversion, limited liquidity in secondary markets

How to Choose the Right Financing

  • Assess the company's financial needs, growth objectives, and risk tolerance
  • Analyze the cost of capital associated with each financing option
    • Debt: Interest rates, repayment terms, and collateral requirements
    • Equity: Required rate of return for investors and dilution of ownership
  • Consider the company's current capital structure and target debt-to-equity ratio
  • Evaluate the impact of financing decisions on key financial metrics (profitability ratios, liquidity ratios)
  • Assess the company's ability to meet long-term financial obligations under various economic scenarios
  • Consider the flexibility and covenants associated with each financing option
  • Align financing decisions with the company's overall business strategy and stakeholder expectations

Key Terms and Concepts

  • Capital structure: The mix of debt and equity used by a company to finance its operations and growth
  • Financial leverage: The use of debt to increase the potential return on equity
  • Cost of capital: The weighted average cost of debt and equity financing
  • Debt-to-equity ratio: A measure of a company's financial leverage, calculated by dividing total debt by total equity
  • Bond rating: An assessment of a company's creditworthiness and ability to repay its debt obligations
  • Dilution: The reduction in ownership percentage experienced by existing shareholders when new shares are issued
  • Covenants: Legally binding agreements between a borrower and lender that outline the terms and conditions of a loan

Real-World Examples

  • Apple Inc. issued $14 billion in corporate bonds in 2020 to fund share buybacks and dividends
  • Tesla, Inc. raised over $12 billion through a combination of equity offerings and convertible debt between 2019 and 2021
  • General Electric divested assets and focused on reducing its debt load to improve its long-term financial stability
  • Marriott International raised $920 million through a combination of senior notes and equity in 2020 to navigate the COVID-19 pandemic
  • Walmart has maintained a balanced capital structure with a mix of debt and equity financing to support its global expansion

Wrapping It Up

  • Long-term financing is essential for companies to fund growth, acquire assets, and maintain financial stability
  • Companies must carefully consider the pros and cons of different financing options (debt, equity, hybrid securities)
  • Choosing the right financing mix involves analyzing the cost of capital, financial metrics, and alignment with business objectives
  • Effective long-term financing decisions optimize the capital structure and support sustainable growth
  • Monitoring and adapting financing strategies based on changing market conditions and company performance is crucial
  • Balancing the interests of various stakeholders (shareholders, creditors) is essential when making long-term financing decisions


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© 2024 Fiveable Inc. All rights reserved.
AP® and SAT® are trademarks registered by the College Board, which is not affiliated with, and does not endorse this website.
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