Nalyzing a firms current financing choices

Analyzing a Firm s Current Financing Choices

Objective: To examine a firm s current financing choices and to categorize them into debt (borrowings) and equity and to examine the trade-off between debt and equity for your firm.

Deliverable: A brief overview of the financing choices of a firm of your choice. It will make your analysis much easier if you choose a public firm that reports to the SEC. Your memo should be no longer than five pages, plus tables. Please make sure that it is formatted for easy printing. (Note  I do not necessarily expect five pages. Just make sure you cover the main points outlined below.)

The information about current financing choices can be extracted from the financial statements. The balance sheet should provide a summary of the book values of the various financing choices made by the firm, though hybrids are usually categorized into debt and equity. The description of warrants outstanding as well as the details of the borrowing that the firm has should be available in the footnotes to the balance sheets. In particular, the maturity rates for different components of borrowing, the coupon rates and information on any other special features should be available in the notes. Chapter 15 of your text book provides lots of information on using financial statements to understand the capital structure of a firm.

All financial statements of public companies are available on the SEC EDGAR homepage: New_Home_Page/eqdata.htm .

KEY QUESTIONS TO CONSIDER IN YOUR ANALYSIS:
o Where and how does the firm get its current financing?
o Would these financing choices be classified as debt, equity, or hybrid securities?
o How large, in qualitative or quantitative terms, are the advantages to this company from using debt?
o How large, in qualitative or quantitative terms, are the disadvantages to this company from using debt?
o From the qualitative trade-off, does this firm look like it has too much or too little debt?

FRAMEWORK for ANALYSIS (You don t need to answer these point by point. They are meant as a framework of how you might want to think about the above key questions.)

1. Assessing Current Financing

a. How does the firm raise equity?
E.g., if it is a publicly traded firm, it can raise equity from common stock, preferred stock, warrants. If it is a private firm, the equity can come from personal savings and venture capital.

b. How (if at all) does the firm borrow money?
If it is a publicly traded firm, it might raise debt from bank debt or corporate bonds.

c. Does the firm use any hybrid approaches to raising financing that combine some features of debt and some of equity? Examples would included preferred stock, convertible bonds, and bonds with warrants attached to them.


2. Detailed Description of Current Financing

a. If the firm raises equity from warrants or convertibles, what are the characteristics of the included options (exercise price, maturity, etc.)?
b. If the firm has borrowed money, what are the characteristics of the debt (maturity, coupon or stated interested rate, call features, fixed or floating rate, secured or unsecured, and currency)?
c. If the firm has hybrid securities, what are the features of the hybrid securities?


3. Breakdown into Debt and Equity

a. If the firm has financing with debt and equity components, how much of the firm s value can be attributed to debt and how much to equity.
b. How would you use the coupon or stated interest rate and maturity of the debt to estimate its current market value as opposed to the book value. (You do not need to do this calculation  simply explain what factors go into market value calculation.)
c. What is the market value of the firm s outstanding equity.


4. Trade-Off on Debt vs. Equity

a. Benefits of debt
Does the firm seem to benefit from the tax impact of debt? Does the firm have taxable income?
Does debt seem to be important in controlling agency problems in the firm? Does the firm have high free cash flows  e.g., EBITDA / firm value? Does the firm make good investment choices? Do managers seem to make choices that are in shareholders interests?
Are there other factors about this firm that seem to be consistent with the financing choices made by managers?

b. Costs of debt
How high are the current cash flows of the firm (to service the debt) and how stable are these cash flows? Look at the variability of operating income over time.
How easy is it for bondholders to observe what equity investors are doing? Are the assets tangible or intangible?
How well can this firm forecast its future investment opportunities and needs?

Yes, the readability of your memo does matter. Be clear and precise. Make sure that any tables you include are easy to understand and formatted beautifully.