🗃️Corporate Finance Unit 10 – Long–Term Financing

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