Ch' 14: WorkingCapital Management

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• Appreciate the significance of bond type
  instruments, terms loans and leases for raising
  medium to long term finance
• analyse the working of bonds, term loans and
  leases
• know how to determine the true cost of such
  financing sources
• understand the various types of lease
  arrangements
• know how to evaluate a lease and compare this to
  loan finance and hire purchase

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• Types of Issues
• Family offer of new securities to firms
  existing security holders
• Private offer of new securities to a select
  group of potential investors
• Public Issue offer of new securities to the
  public requires a prospectus trustee and trust
  deed necessary

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• Issued directly to primary investors
• Issuer requires a high debt rating

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• Consider
• coupon rate
• issue/ flotation costs
• marketability

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• Characteristics of Term Loans
• Secured loans
• 1 to 10 year maturity
• Fixed or floating rate
• Repaid in periodic installments (annuity)

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• Margin reflects
• lenders desired profit level
• access to alternative sources of funds
• borrowers credit standing and the risk of the
  loan
• relationship between lender and customer
• Fees - establishment, administration

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• Restrictive Covenants on Borrowers
• Working capital - borrower may be required to set
  a minimum current ratio.
• Restrictions on additional borrowing.
• Borrower provides periodic financial statements.
• Restrictions on management changes
• Restrictions on asset sales.

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• Lessee
• Acquires the services of a leased asset, by
  making a series of payments to the owner of the
  asset.
• Lessor
• The owner of the asset that is being leased to
  the lessee.

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• Types of Leases
• Finance Lease - non cancellable contractual
  commitment on the part of the lessee to make a
  series of payments to the lessor for the use of
  the asset. Most of the risks and benefits of
  ownership pass to the lessee.
• Operating Lease - contractual commitment on the
  part of the lessee to make a series of payments
  to the lessor for use of the asset

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• Lease Arrangements
• Direct Lease - a firm acquires the services of an
  asset that it didnt previously own.
• Sale and Leaseback - Assets owner sells the
  asset to a buyer, and then leases the asset from
  the buyer.
• Leveraged Lease - Lessor borrows from a lender to
  buy the asset that will be leased to the lessee.

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• Issue Should a firm
• Purchase an asset using the firms optional
  financing mix (borrow to buy), or
• Finance the asset using a financial lease?

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• Procedure
• 1) Compute NPV to determine if the asset should
  be purchased.

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• Procedure
• 2) Compute NAL (net advantage to leasing) to
  determine if leasing the asset is better for the
  firm than purchasing.
• NAL PVL - PVB
• where
• PVL present value of leasing
• PVB present value of borrowing

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• For both corporations and non-corporate
  businesses, we will evaluate leases on an
  after-tax basis.

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• 1. Identify the direct lease cash flows
• proceeds of lease, lease payments, tax benefit
  from lease payment, tax consequences of selling
  leased asset
• 2. Identify the indirect lease cash flows
• depreciation tax benefits foregone, tax avoided
  on sale of depreciated asset
• 3. Determine the present value of borrowing
• discount the future net cash flows required to
  service the lease at the cost of borrowing

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• Agreement whereby the hirer has the right to use
  goods and services or property in return for the
  obligation to make a series of payments to the
  financier. Unlike a lease, ownership of the
  goods/property passes automatically to the hirer.

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• Cost versus risk trade-off
• Preference for one form over another is only
  clear cut when
• one alternative is both less costly and less
  risky than the other
• one alternative is less costly and equally risky
• one alternative is less risky and equally costly

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• Long term debt
• debentures and bonds
• term loans
• leasing hire purchase
• Potential benefits, costs and evaluation of the
  various sources