Raising Long-Term Financing: Discussion

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Из курса от партнера University of Illinois at Urbana-Champaign

Corporate Finance I: Measuring and Promoting Value Creation

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University of Illinois at Urbana-Champaign

Corporate Finance I: Measuring and Promoting Value Creation

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Курс 5 из 7 — Specialization Financial Management

In this course you will learn how to use key finance principles to understand and measure business success and to identify and promote true value creation. You will learn how to use accounting information to form key financial ratios to measure a company’s financial health and to manage a company's short-term and long-term liquidity needs. You will also learn how to use valuation techniques to make sound business investment and acquisition decisions. Finally, you will learn how to incorporate risk and uncertainty into investment decisions and how to evaluate the performance of existing investments. Upon successful completion of this course you will be able to: • Understand how companies make investment decisions that create value for shareholders • Use accounting statements to measure the financial health of a company • Forecast and manage a company’s short- and long-term liquidity needs • Measure the contribution of a new project or acquisition to shareholder value • Incorporate risk into investment decisions using the appropriate discount rates • Evaluate the performance of a company or divisions of a company This course was previously entitled Financial Evaluation and Strategy: Corporate Finance. The course received an average rating of 4.7 out of 5 based on 177 reviews over the period of September 2015 through August 2016. A detailed breakdown of ratings and reviews received for the prior version of the course, which is identical in content to the current course, is provided in the course orientation page. This course is part of the iMBA offered by the University of Illinois, a flexible, fully-accredited online MBA at an incredibly competitive price. For more information, please see the Resource page in this course and onlinemba.illinois.edu.

Из урока

Module 2: Financial Planning

In Module 2, we will learn models that allow us to forecast and manage a company's short-term investments such as capital expenditures. We will forecast the future financial statements of a real world company and learn how to figure out how much external financing the company will need. We will then use real world examples to learn how short-term investments in working capital determine a company's need for short-term financing.

Raising Long-Term Financing: Discussion9:03

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Heitor Almeida
Professor of Finance, Stanley C. and Joan J. Golder Chair in Corporate Finance
Department of Finance, College of Business

[MUSIC]

So we just discussed Pepsicos' long term financial plan, right?

Our answer was that Pepsico could probably

finance the expansion using internal funds, but

there are reasons why the company may want to issue new long term financing, okay.

And this is obviously a very important topic in corporate finance.

If a company decides that it does need new long term financing, right?

How should you do it?

There are many issues to think about here, right?

So, we call this the capital structure decision.

So, how do companies finance themselves?

What kind of securities should they issue, right?

To talk about all of these issues would be beyond the scope of this model, okay.

This is something that we're not gonna cover so much in this course.

But I just wanted to highlight a few of the key issues that the company would need

to consider.

So just for completeness, lets talk about a few of the issues that Pepsico

would need to consider, if it does decide to issue new external funds, okay?

So the first issue to consider is which source of financing to use.

Right?

So as you need for example x $3 billion off cash, let's say.

There are many ways you can raise this money, right?

You can raise the money by issuing a new stock.

You can raise the money by issuing a bond.

Or you can go to a bank and borrow the money, right?

So there are many factors that a chief financial officer would need to

think about here, including taxes, liquidity, how much leverage you have.

Remember we talked about leverage in module one.

Now we know how to measure how level the company is.

We have to think about market conditions, right?

What interest rates look like, risk, many other considerations.

Okay.

Like I said, in this course, we don't have the room to talk about

capitalist structuring in that detail, okay.

But this is something that we will cover in a future course, if you're interested.

There will be a second corporate finance course,

that we're going to do, and we're going to be talking about this, okay.

Anyway, for

us at this point, let's say that Pepsico decides to issue a bond, okay.

Suppose you consider all of this and

you're going to raise the money by issuing a bond, okay.

First question to think about.

When should you do it, right?

We have our financial planning model,

we know that Pepsico is not going to need the money until 2016.

Okay?

So it's not, your cash is going to stay constant.

There's no need to get any new financing until that year.

So you might think that it may be better for Pepsico to just wait.

Right? Just sit and

wait, until 2016 comes and then you issue the bond, right?

Of course the advantage of that,

is that Pepsico won't have to pay any interest, right?

So if you don't issue that until but 2016,

you're not gonna pay any interest on that, okay?

The deals advantage which maybe less clear, right?

Is that you're never sure what market conditions will be in 2016, right?

So, it's the future and we never know what's gonna happen, for

example what if we have a new financial crisis.

Okay.

And this actually allows me to talk a little bit about the, some research

that I've done in a paper that I recently wrote with Scott Weisbanner,

that was one of the other professors in this specialization actually.

And some of our where we look at corporate debt during the recent financial crisis.

We had a financial crisis around the world in 2007, from 2007 to 2009.

Our paper examines what happens to companies during that time.

And a very interesting finding that we have in that paper, is that companies that

were forced to issue new debt at the height of the financial crisis, right?

In 2008, did worse than companies that were in a stronger financial position.

Okay?

So it's a little bit like the situation we are discussing here.

Pepsico is thinking about should I issue the debt today or should I wait?

Okay? If you wait, you know,

you might end up being a year where market conditions are really bad.

If you are forced to issue that in that year, you may not be able to issue it,

like banks may say no.

Or you might have to pay a much higher interest rate, okay.

An interesting example that we discuss in our paper is the case of Avis and Budget,

which are two car rental companies here in the US.

I know they actually operate around the world.

And what happened is that,

before the financial crisis they were both independent companies.

They were competitors.

Okay.

But budget was exactly in the situation that we are describing here.

Budget was forced to issue debt in 2008,

to refinance some long term bad debt was maturing in that year.

While Avis was in a much higher financial position.

And if you read the news, if you read the history, what you'll see,

is that Avis ended up acquiring Budget, following the financial crisis.

So Budget was actually acquired by Avis partly because it was going through

financial trouble, and it ended up being swallowed by the competitor, okay?

So poor financial management can have very extreme consequences for

companies, that's what we show in our research, okay?

So it may not be a good idea going back to our Pepsico example.

Pepsico may actually want to issue the debt today,

instead of waiting until the future.

Okay? The second question is how much, right?

Suppose you need to, you decide that you need lets say 2 billion dollars, okay?

To finance this needed expansion plan.

Should the company borrow exactly two billion, right?

Again, the advantage is to minimize interest payments, right?

If you borrow just what you need, you're gonna be paying less interest, but

there is a risk as well, right?

Think about what could be this risk.

It's actually related to what we just discussed.

The idea of precaution, right?

It might be safer to borrow more,

it might sound counter intuitive that having less leverage makes you safer.

But when you think about this problem, you may actually be safer to borrow more than

two billion dollars despite the additional interest.

Why is that?

We have this forecasting model, our forecasting model is telling us,

yes we're gonna need 2.6 billion, but the forecasting model could be wrong.

Right?

Maybe Pepsico is gonna do worse than what we expect,

there might be other expenses, there might be other cash needs, okay?

It actually you know, Pepsico CFO might actually consider

whether it's worthwhile to borrow more, than what you need.

Right?

Just for precautionary reasons.

And we call this precautionary borrowing.

Okay? And here comes a question.

So If you're going to engage in this precautionary borrowing, if you're gonna

borrow more than you need, what are you going to do with the excess funding?

Right? So what should Pepsico do with the cash?

The answer is that you have to hold cash, right?

So for these excess funding to give you financial security,

you can't spend it, okay?

You have to hold the cash in the balance sheet.

And again, this allows me to talk about some research that I've done,

where we make precisely this point that holding cash in a sense is

economically equivalent to this precautionary borrowing idea, right?

A company that decides to hold cash,

could potentially use that cash to reduce the leverage.

One use of the cash is to repay that.

Right?

So if you decide to hold cash in the balance sheet, in a sense,

you're really deciding to have higher leverage as well.

Right?

Or to put it in another way, a company that does precautionary borrowing that

borrows more than what it needs, is going to end up holding more cash.

Okay?

And that might be, despite the higher cost of this financial strategy,

it might end up making sense for a company that needs to take precautions

against a future cash flow shocks, against future liquidity shocks.

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