Chapter 13-1AnnouncementsLearning ObjectivesDebt versus Equity FinancingDebt FinancingSlide 6Slide 7What is the Risk of Debt Financing?Times Interest EarnedWhat is the Reward of Debt Financing?Equity FinancingSlide 12Return on EquityROE ExampleWhat have we learned?Financial RatiosDebt-to-EquityTypes of Business CombinationsBusiness Combinations: What are the Advantages of Sole Proprietorships and Partnerships?Business Combinations: What are the Disadvantages of Sole Proprietorships and Partnerships?What are the Advantages of Corporations?What are the Disadvantages of Corporations?How do Partnerships Determine how Profits/Losses will be Allocated to the Partners?Slide 24Slide 25How do Partnerships Determine how Profits/Losses will be Allocated to the Partners?How do Partnerships Determine how Profits/Losses will be Allocated to the Partners? P13.1Chapter 13-2Slide 29Slide 30Raising Capital through Equity FinancingWhat are the Types of Stock Issued by Corporations?What are the Most Common Preferences given to Preferred Stock?Dividend PreferenceExample: Noncumulative Preferred StockExample: Noncumulative PreferredExample: Cumulative PreferredWhat are the Different “Numbers of Shares” Concerning Stock?Issuing StockWhat is Treasury Stock?Treasury StockWhat are the “Values” Associated with Stock?What Types of Dividends are Distributed?DividendsWhat are the 4 Dates Associated with Dividends?Dividend AnnouncementCash DividendsWhat is the Difference Between a Stock Dividend and a Stock Split?Stock DividendsMcGraw-Hill/IrwinCopyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.Chapter 13-1Chapter 13-1Planning Equity Financing13-2AnnouncementsAnnouncementsOur first exam is set for 2/8. Exam locations are posted in DESIRE2LEARN.If you have submitted a note to me regarding an exam conflict and have not heard back from me, send me an email today!The study guide is posted under the exam section of the Desire2Learn discussion board.New Chapter 12 Learnsmart Due Date 2/4 at 5:00 PM.13-3Learning ObjectivesLearning Objectives•LO1 Explain how companies plan for debt vs equity financing•LO2 Describe how partnership profits and losses are allocated•LO3 Discuss the process of raising capital through equity financing in a corporation•LO4 Explain the process of giving stockholders a return on investment•LO5 Compare and contrast stock dividends and stock splits13-4Debt versus Equity FinancingDebt versus Equity FinancingoChapter 12 discussed various reasons why businesses might need to acquire new assets oThe funding for these assets has to come from some place.ASSETS =ASSETS = LIABILITIESLIABILITIES ++ OWNERS' EQUITYOWNERS' EQUITY13-5Debt FinancingDebt FinancingoLiabilities are the debts of the company. They can be short-term (generally due within one year) or long-term in nature. oThey can be informal and arise through the normal course of business (accounts payable; wages payable) or they can be more formal borrowings from third parties (notes and bonds payable)ASSETS = LIABILITIES + OWNERS' ASSETS = LIABILITIES + OWNERS' EQUITYEQUITY13-6oAs we discussed with the cost of capital in Chapter 12, creditors expect a Rate of ReturnRate of Return on their investment equivalent to the rate that makes loaning the money “worthwhile.” This is the agreed-upon interest rate associated with the debt.Debt FinancingDebt FinancingASSETS = LIABILITIES + OWNERS' ASSETS = LIABILITIES + OWNERS' EQUITYEQUITY13-7oThe interest paid on debt is an expense (reduces net income) and is deductible for tax purposes.oTaxes go down when interest expense is deducted on the tax return. This, in turn, reduces the company’s cost of carrying the debt and the rate actually paid on the debt.Debt FinancingDebt FinancingASSETS = LIABILITIES + OWNERS' ASSETS = LIABILITIES + OWNERS' EQUITYEQUITY13-8What is the Risk of Debt Financing?What is the Risk of Debt Financing?•Financial riskThe chance that the company cannot meet its debt obligations as they become due•MeasuresDebt to equity ratio (relationship of total debt to total owners’ equity) Total Debt/Total Equity (E13.1)Times interest earned ratio (relationship of income before interest and taxes to interest expense) NI before I and T/Interest Expense13-9USS AccountantNI before I & T ÷ Interest NI before I & T ÷ Interest expenseexpenseWatson, Inc. expects to earn income before interest and taxes of $600,000 during the year. If its interest expense is $50,000, what is Watson’s times interest earned ratio? Times Interest Earned Times Interest Earned$600,000 ÷ $50,000 = 12$600,000 ÷ $50,000 = 12What does this What does this mean?mean?E13.213-10What is the Reward of Debt Financing?What is the Reward of Debt Financing?•Financial leverageThe opportunity to generate a return that is greater than the cost of borrowing. When a company uses borrowed funds to earn a rate of return that exceedsexceeds the cost of debt, financial leverage has a positive effect for shareholders!•MeasureReturn on equity (relationship of net income to total owners’ equity)13-11oAnother way to finance assets is through Owners' Equity (OE). In Acct 2101 you learned that OE consists of two components:amounts raised through issuing stock to shareholders, andamounts raised by the company itself through retained earningsEquity FinancingEquity FinancingASSETS = LIABILITIES + OWNERS' ASSETS = LIABILITIES + OWNERS' EQUITYEQUITY13-12oOne difference between debt and equity financing is that while interest is deductible in arriving at net income (and taxable income), dividends are not deductibleFor example, a company with net For example, a company with net income of $50,000 distributes income of $50,000 distributes $10,000 to its shareholders. Since $10,000 to its shareholders. Since no tax savings are derived from no tax savings are derived from paying dividends, the cost of paying dividends, the cost of paying the dividend is $10,000 and paying the dividend is $10,000 and retained earnings is reduced by the retained earnings is reduced by the $10,000. $10,000. Equity FinancingEquity FinancingASSETS = LIABILITIES + OWNERS' ASSETS = LIABILITIES + OWNERS' EQUITYEQUITY13-13oROE is a financial ratio that measures a company’s performance by relating after-tax net income to the owners' investment.Return on EquityReturn on EquityROE = after-tax NI ÷ Owners' ROE = after-tax NI ÷ Owners' EquityEquity13-14ROE = ROE