Free Corporate
Finance Tutorials from FinanceScholar.com
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Imagine you borrow $10,000 now at a rate of 12% interest
annually, for the next 30 years. You will therefore pay 0.12 x
$10,000 = $1200 per year for the next 30 years. At the end of
the 30 years, you will also pay back the original $10,000 (principal
amount). What is the total amount you have paid?
$1200 per year x 30 years = $36000 (interest payments)
$10,000 (original principal)
Total payments = $36,000 + $10,000 = $46,000
This section is similar to the section on valuating bonds.
If you recall, a corporation can finance its operations in 2 ways:
1) Issue bonds (debt financing)
2) Issue common or preferred stock shares
We will go on to value these common and preferred stock shares
using various dividend growth formulas.
Indifference Earnings Before Interest & Taxes (Indifference
EBIT) is the point of the capital structure where the corporation
does not care about whether they issue new debt, have no debt
and 100% equity or have a combination of both debt & equity.
From the graph below, you can determine that the Indifference
EBIT point is where the With Debt Capital Structure Line intersects
with the No Debt Capital Structure Line.
M&M Proposition I states that the value of a firm
does NOT depend on its capital structure. For example, think of
2 firms that have the same business operations, and same kind
of assets. Thus, the left side of their Balance Sheets look exactly
the same. The only thing different between the 2 firms is the
right side of the balance sheet, i.e the liabilities and how they
finance their business activities.
Weighted Average Cost of Capital (WACC) is therefore
an overall return that a corporation MUST earn on its existing
assets and business operations in order to increase or maintain
the value of the current stock. For example, if Microsoft's WACC
is 15% and current stock price is 28$, then the company must earn
a 15% return on its existing assets and business operations (net
income) in order to MAINTAIN the stock price at $28. The last
thing that corporations would wish to happen is their stock price
falling down!
Fixed rate bonds are what the name implies, they provide
a fixed coupon interest payment at each period (monthly, quarterly,
semi-annually or annually) for a certain # of years up until maturity.
Upon maturity, fixed rate bonds pay back the entire original principal
amount. Go here to learn more about bond debt securities. (View
Full Tutorial)
Imagine the current stock price of a XYZ Corp. is $42.45
Also, the annual dividend payment per share that it pays out is
$1.25. Using this information, what is the dividend yield?
Dividend Yield = Dividend per Share / Current Share Price
Dividend Yield = $1.25 / 42.45
Dividend Yield = 0.0295 = 2.95%
Zee Zee Inc. issued bonds with a face value of $50,000,000.
The bonds are currently yielding 4% return with a coupon rate
of 5% interest paid quarterly. The # of years till maturity is
10 years. The corporation just paid a dividend of $3 per share.
The dividends are expected to grow at 6% per year indefinitely
with the current stock price being at $18 per share. There are
1,500,000 common shares outstanding at this time. Assuming a tax
rate of 40%, calculate Zee Zee Inc.'s Weighted Average Cost of
Capital (WACC). (View
Full Tutorial)
In our tutorial on long term time value of money, we
explained compound interest in the form of annually compounded
interest. What happens if the interest is not compounded annually
(once a year), but quarterly (4 times a year) or monthly (12 times
a year)? In these circumstances, our money would grow much faster
at monthly compounding, as opposed to annual compounding. Let's
take a look: (View
Full Tutorial)
Degree of Financial Leverage measures the amount of risk
a company takes up when it borrows more debt (and increases the
debt portion of its capital structure). The formula for Degree
of Financial Leverage is:
| Degree of Financial
Leverage = |
Earnings Before Interest
& Taxes (EBIT)
Earnings Before Taxes (EBT) |
(View
Full Tutorial)
