Tài chính doanh nghiệp - Chapter 10: Medium - To longer - term debt

Chapter 10Medium- to Longer-term DebtCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonLearning ObjectivesIdentify the types of medium- to long-term debt instruments in the marketUnderstand the securitisation processPricing of longer-term debt instrumentsCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonChapter Organisation10.1 Introduction10.2 Term Loans or Fully-drawn Advances10.3 Mortgage Finance10.4 Debentures, Unsecured Notes and Subordinated DebtCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonChapter Organisation (cont.)10.5 Calculations: Fixed Interest Securities10.6 Leasing10.7 Direct Credit Substitutes10.8 SummaryCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson10.1 IntroductionMatching principleFirms should match the maturity structure of their assets with the maturity structure of their sources of funds (liabilities and shareholder funds)Therefore, longer-term assets should be funded with longer-term liabilities and equityThe repayment schedule of debt financing for long-term projects should align with the project’s expected future cash flowsCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson10.1 Introduction (cont.)Repayment may beInterest only during term of loan and principal repayment on maturityAmortised loan (credit foncier loan)periodic loan instalments consisting of interest due and reduction of principalDeferred repayment loanloan instalments commence after a specified period related to project cash flows, and the debt is amortised over the remaining term of the loanCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonChapter Organisation10.1 Introduction10.2 Term Loans or Fully-drawn Advances10.3 Mortgage Finance10.4 Debentures, Unsecured Notes and Subordinated DebtCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson10.2 Term Loans or Fully-drawn AdvancesFixed-term loan periods generally range from 3 to 15 yearsTypically used to finance capital expenditure e.g. building, equipmentRepayment can be amortised or deferredCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson10.2 Term Loans or Fully-drawn Advances (cont.)Interest may be fixed or variable, is linked to an indicator rate e.g. BBSW or bank’s prime rate, and is influenced byCredit risk of borrower (risk premium)Term of the loanRepayment scheduleCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson10.2 Term Loans or Fully-drawn Advances (cont.)Other fees includeEstablishment feeService feeCommitment feeLine feeBill option clause feeCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson10.2 Term Loans or Fully-drawn Advances (cont.)Loan covenantsRestrict the business and financial activities of the borrowing firm Positive covenant requires borrower to take prescribed actions e.g. maintain a minimum level of working capitalNegative covenant restricts the activities and financial structure of borrower e.g. amount of dividend, maximum debt to equity ratioCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson10.2 Term Loans or Fully-drawn Advances (cont.)Loan covenants (cont.)Breach of covenant results in default of the loan contract entitling lender to actCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson10.2 Term Loans or Fully-drawn Advances (cont.)Calculating the loan instalment— ordinary annuity(10.1)Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson10.2 Term Loans or Fully-drawn Advances (cont.)Calculating the loan instalment— ordinary annuity (cont.)Example 1: Floppy Software Limited has approached Mega Bank to obtain a term loan to finance the purchase of a new high-speed CD burner. The bank offers a $150,000 loan, amortised over five years at 8 per cent per annum, payable monthly. Calculate the monthly loan instalments.Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson10.2 Term Loans or Fully-drawn Advances (cont.)Calculating the loan instalment— ordinary annuity (cont.)Example 1 (cont.)Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson10.2 Term Loans or Fully-drawn Advances (cont.)Calculating the loan instalment—annuity due(10.2)Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson10.2 Term Loans or Fully-drawn Advances (cont.)Calculating the loan instalment—annuity due (cont.)Example 2: A business proprietor is purchasing a computer system for the business at a cost of $21,500. a finance company has offered a term loan over seven years at a rate of 12 per cent per annum. The loan will be repaid by equal monthly instalments at the beginning of each month. Calculate the amount of the loan instalments.Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson10.2 Term Loans or Fully-drawn Advances (cont.)Example 2 (cont.)Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonChapter Organisation10.1 Introduction10.2 Term Loans or Fully-drawn Advances10.3 Mortgage Finance10.4 Debentures, Unsecured Notes and Subordinated DebtCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson10.3 Mortgage FinanceA mortgage is a form of security for a loanThe borrower (mortgagor) conveys an interest in the land to the lender (mortgagee)The mortgage is registered on the land titleCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson10.3 Mortgage Finance (cont.)The mortgage is discharged when the loan is repaidIf the mortgagor defaults on the loan, the mortgagee is entitled to foreclose on the propertyMortgage loans can be either residential or commercialCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson10.3 Mortgage Finance (cont.)Residential loans are typically granted for periods of up to 20 years, while commercial loans are for periods of 5 to 10 years, typicallyVariable interest rate loans dominate, but fixed rates are available for loans with terms of up to 2 yearsCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson10.3 Mortgage Finance (cont.)Mortgagee (lender) may reduce their risk exposure to borrower default byRequiring mortgagor to take out mortgage insuranceMortgagee buying a put option on the mortgage or propertySecuritisation i.e. the sale of mortgage loansThe conversion of non-liquid assets into new asset-backed securities that are serviced with cash flows from the original assetsCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson10.3 Mortgage Finance (cont.)Calculating the instalment on a mortgage loan(10.3)Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson10.3 Mortgage Finance (cont.)Calculating the instalment on a mortgage loan (cont.)Example 3: A company is seeking a fully-amortised commercial mortgage loan of $650,000 from its bank. The conditions attached to the loan include an interest rate of 8 per cent per annum, payable over five years by equal end-of-quarter instalments. The company treasurer needs to ascertain the quarterly instalment amount.Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson10.3 Mortgage Finance (cont.)Calculating the instalment on a mortgage loan (cont.)Example 3 (cont.):Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonChapter Organisation10.1 Introduction10.2 Term Loans or Fully-drawn Advances10.3 Mortgage Finance10.4 Debentures, Unsecured Notes and Subordinated DebtCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson10.4 Debentures, Unsecured Notes and Subordinated DebtThese securities are issued in the corporate bond marketMarkets for the direct issue of longer-term debt securitiesLenders face higherRisk compared to lending indirectly through intermediariesYield due to sharing in the profit margin usually taken by intermediariesCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson10.4 Debentures, Unsecured Notes and Subordinated Debt (cont.)Debentures and unsecured notesAre both described as a corporate bondSpecify that the lender will receive regular interest payments (coupon) during the term of the bond and receive repayment of the face value at maturityDebentures are secured by either a fixed or floating charge over the issuer’s unpledged assetsCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson10.4 Debentures, Unsecured Notes and Subordinated Debt (cont.)Debentures and unsecured notes (cont.)Unsecured notes are bonds with no underlying security attachedDebentures are listed and traded on the stock exchangeDebentures have a higher claim over a company’s assets (e.g. on liquidation) than unsecured note holdersCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson10.4 Debentures, Unsecured Notes and Subordinated Debt (cont.)Issuing debentures and notesThere are three principal issue methodsPublic issue—issued to the public at large, by prospectusFamily issue—issued to existing shareholders and investors by prospectusPrivate placement—issued to institutional investors, prospectus not requiredUsually issued at face value, but may be issued at a discount, or with deferred or zero interestCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson10.4 Debentures, Unsecured Notes and Subordinated Debt (cont.)Subordinated debtMore like equity than debt i.e. quasi-equityClaims of debt holders are ‘subordinated’ behind all other company liabilitiesAgreement may specify that the debt is not presented for redemption until after a certain period has elapsedMay be regarded as equity in the balance sheet and treated as Tier 2 capitalCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonChapter Organisation (cont.)10.5 Calculations: Fixed Interest Securities10.6 Leasing10.7 Direct Credit Substitutes10.8 SummaryCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson10.5 Calculations: Fixed Interest SecuritiesPrice of a fixed interest bond at coupon dateThe price of a fixed interest security is the sum of the present value of the face value and the present value of the coupon stream(10.4)Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson10.5 Calculations: Fixed Interest Securities (cont.)Price of a fixed interest bond at coupon date (cont.)Example 4: Current corporate bond yields in the market are 8 per cent per annum. An existing corporate bond with a face value of $100,000, paying 10 per cent per annum half-yearly coupons, and exactly six years to maturity, would be sold at a price of:Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson10.5 Calculations: Fixed Interest Securities (cont.)Example 4 (cont.):abCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson10.5 Calculations: Fixed Interest Securities (cont.)Price of a fixed interest bond between coupon dates(10.7)Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson10.5 Calculations: Fixed Interest Securities (cont.)Price of a fixed interest bond between coupon dates (cont.)Example 5: Current corporate bond yields in the market are 8 per cent per annum. An existing corporate bond with a face value of $100,000, paying 10 per cent per annum half-yearly coupons, maturing 31 December 2009, would be sold on 20 May 2004 at a price of:Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson10.5 Calculations: Fixed Interest Securities (cont.)Example 5 (cont.):abCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson10.5 Calculations: Fixed Interest Securities (cont.)Example 5 (cont.):cCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonChapter Organisation (cont.)10.5 Calculations: Fixed Interest Securities10.6 Leasing10.7 Direct Credit Substitutes10.8 SummaryCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson10.6 LeasingA lease is a contract where the owner of an asset (lessor) grants another party (lessee) the right to use the asset for an agreed period of time in return for periodic rental paymentsLeasing is the borrowing (renting) of an asset, instead of borrowing the funds to purchase the assetCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson10.6 Leasing (cont.)Advantages of leasingConserves capitalProvides 100% financingMatches cash flows (i.e. rental payments with income generated by the asset)Less likely to breach any existing loan covenantsRental payments are tax deductibleCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson10.6 Leasing (cont.)Types of leasesOperating leaseLessor may lease the asset to successive lessees (e.g. short-term use of equipment)Maintenance and insurance of the asset is provided by the lessorLessee makes rental payments for the period of use of the assetsCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson10.6 Leasing (cont.)Types of leases (cont.)Finance leaseLonger-term financingLessor finances the assetLessor earns return from a single lease contractLessee pays for insurance and maintenanceResidual amount due at end of lease periodOwnership of the asset passes to lessee on payment of the residual amountCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson10.6 Leasing (cont.)Types of leases (cont.)Sale and lease-backExisting assets owned by a company or government are sold to raise cashThe assets are then leased back from the new ownerCross-border leaseA lessor in one country leases an asset to a lessee in another countryCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson10.6 Leasing (cont.)Lease structuresDirectInvolves two parties (lessor and lessee)Lessor purchases equipment with own funds and leases asset to lesseeDirect leases generally run from between 3 and 5 yearsLeased asset price is, generally, less than $100,000Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson10.6 Leasing (cont.)Lease structures (cont.)Leveraged leasingLessors contribute limited equity, and borrow the majority of funds required to purchase the assetAsset then leased to lesseeLessors gain tax advantages of depreciation and interest expense claimsLeased asset price is, usually, large (upwards of $2 million)Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson10.6 Leasing (cont.)Lease structures (cont.)Equity leasingLeased asset cost usually between direct and leveraged range ($100,000 to $2 million)Similar structure to leveraged lease, but lose the leverage advantage due to the smaller amount of debt financing requiredCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonChapter Organisation (cont.)10.5 Calculations: Fixed Interest Securities10.6 Leasing10.7 Direct Credit Substitutes10.8 SummaryCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson10.7 Direct Credit SubstitutesThese are OBS arrangements that allow a corporation or government to substitute or replace an actual borrowing of funds with an undertaking from a financial institution such as a bankCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson10.7 Direct Credit Substitutes (cont.)Three categories of direct credit substitutesLetter of credit—an irrevocable undertaking to meet a financial commitment in the event of default by a named partyLetter of comfort—advice given by a parent company provided reassurance that its subsidiary can meet its obligationsCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson10.7 Direct Credit Substitutes (cont.)Three categories of direct credit substitutes (cont.)Guarantee—a guarantor agrees to assume the liabilities of a third party in the event of defaultCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonChapter Organisation (cont.)10.5 Calculations: Fixed Interest Securities10.6 Leasing10.7 Direct Credit Substitutes10.8 SummaryCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson10.8 SummaryWhen choosing the most appropriate source of medium- to longer-term debt, a borrower should consider the following factorsMatching the maturity and repayment schedule of debt with cash flows generated by assets financed by debtFixed or variable interest rateTerm of the financing arrangementRepayment scheduleLoan covenantsCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson10.8 Summary (cont.)When choosing the most appropriate source of medium- to longer-term debt, a borrower should consider the following factors (cont.)Whether secured by fixed or floating charge, or unsecuredImpact on capital adequacy requirements of borrowing corporationImpact of direct credit substitutes on the availability and cost of fundsLeasing an asset as opposed to buying an assetCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson