instruments of long term finance
TRANSCRIPT
INSTRUMENTS OF LONG TERM FINANCE
LONG TERM FINANCE
• Shares• Debentures • Term Loans• Convertible debentures• Warrants• Zero Interest Debentures• Deep Discount Bonds• Secured Premium Notes
LONG TERM FINANCE (2)
Asset Based Financing
• Lease• Hire Purchase• Project Financing
Venture Capital Finance
Shares
Features of Ordinary Shares• Claim on Income: Residual ownership claim• Claim on Assets: Residual claim• Right to control• Voting rights• Pre-emptive rights• Limited Liability
Shares (2)
Pros and cons of equity Financing
Advantages:
• Permanent capital
• Borrowing Base
• Dividend payment discretion
Shares (3)
Disadvantages
• Cost
• Earnings dilution
• Ownership dilution
Issue of Equity
• Public Issue of equity
Underwriting of issues
• Private Placement
• Rights Issue of equity shares
Preference Shares
Features• Claims on income and assets• Fixed dividend• Cumulative dividends• Redemption: Sinking fund & Call• Participation feature• Voting rights• Convertibility
Pros and Cons of Preference Shares
Advantages• Riskless Leverage• Dividend postponability• Fixed dividend• Limited voting rights
Limitations• Non-deductibility of dividends• Commitment to pay dividend
Debentures
Features• Interest Rate• Maturity• Redemption
Sinking Fund
Buy-back (call) provision• Indenture: Debenture trust deed• Security• Yield• Claims on assets and income
Types of Debentures
• Non-convertible Debentures
• Fully-convertible Debentures
• Partly-convertible Debentures
Pros and cons of Debentures
Advantages• Less costly• No overall dilution• Fixed payment of interest• Reduced real obligation
Limitations• Obligatory payment• Financial Risk• Cash Outflows• Restricted covenants
Term Loans
Features• Maturity• Direct negotiation• Security• Restrictive covenants• Convertibility• Repayment schedule
Convertible Debentures
Why issue convertible debentures• Sweetening fixed-income securities
• Deferred equity financing
• Avoiding earnings dilution
• Raising low cost capital
Warrants
A warrant entitles the purchaser to buy a fixed number of ordinary shares at a particular price during a specified time period.
Characterisitics• Exercise price• Exercise ratio• Expiration date• Detachability• Right
Warrants
Why issue warrants
• Sweetening debt
• Deferred equity financing
• Cash inflow in future
Other Types of Debentures
• Zero interest debentures
• Deep–discount bonds
• Secured premium notes
Lease
Lease is a contract between the lessor, the owner of the asset, and a lessee, the user of the asset.
Some Terms:• Up-front lease• Back-ended lease• Primary lease• Secondary lease
Types of Leases
• Operating lease
• Financial lease
• Sale and lease back
Cash Flow Consequences of a Financial Lease
• Avoidance of the purchase price
• Loss of depreciation tax shield
• After-tax payment of lease rentals
Advantages of Leasing
• Convenience and flexibility
• Shifting the risk of obsolescence
• Maintenance and Specialized services
Hire Purchase FinancingDifference between Leasing and Hire
PurchaseHire Purchase Financing
Lease Financing
Depreciation: claimed by the hirer
Lessee is not entitled to claim depreciation
HP Payments: Hirer can charge only interest portion of payment as expenses for tax purposes
Lessee can charge the entire lease rental as expenses for tax purposes
Salvage Value: Hirer becomes owner after payment of last installment
Lessee does not become the owner of the asset
Project Financing
• In project financing, the project, its assets, contracts, inherent economics and cash flows are separated from their promoters or sponsors in order to permit credit appraisal and loan to the project independent of the sponsors.
• The assets of the specific project serve as collateral for the loan, and all loan repayments are made out of the cash flows of the project.
Characterisitics of Project Financing
• A separate project entity is created that receives loans from lenders and equity from sponsors.
• The component of debt is very high in project financing. Thus project financing is a highly leveraged financing.
• The project funding and all its cash flows are separated from the parent company’s balance sheet.
Characteristics of Project Financing (2)
• Debt services and repayments entirely depend on the project’s cash flows. Project assets are used as collateral for loan repayments.
• Project financiers’ risks are not entirely covered by the sponsor’s guarantees.
• Third parties like suppliers, customers, government and sponsors commit to share the risk of the project.
Project Financing Arrangements
• Build-Own-Operate-Transfer (BOOT)
• Build-Own-Operate (BOO)
• Build-lease-Transfer (BLT)