ES40
Engineering Economy
CAPITAL FINANCING
ENGR. ARCEL SALEM
[email protected] Key Terms
1. Equity Capital or Ownership Funds
• Fund that are supplied and used by the owners of an enterprise in the
expectation that a profit will be earned
2. Borrowed Capital
• Fund that are supplied by others on which a fixed rate of interest must
be paid and the debt must be repaid at a specified time
Equity vs. Debt
Basis for Comparison DEBT EQUITY
Funds owed by the company towards Funds raised by the company by
Meaning
another party issuing shares
What is it? Loan Funds Own Funds
Reflects Obligation Ownership
Term Comparatively short term Long term
Status of holders Lenders Proprietors
Risk Less High
Types Term loan, Debentures, Bonds, etc. Shares and Stocks
Return Interest Dividend
Nature of Return Fixed and regular Variable and irregular
Essential to secure loans, but funds
Collateral Not required
can be raised
Types of Business Organizations
1. Individual Ownership
• Also called sole proprietorship.
• The simplest form of business organization, wherein a person uses his or her own
capital to establish a business and is the sole owner.
Advantages:
Easy to organize
Owner has full control of the enterprise
Owner is entitled to whatever benefits and profits that accrue from the business.
Easy to dissolve
Disadvantages:
limited amount of equity capital
the organization ceases upon the death of the owner
difficult t obtain borrowed capital due to the uncertainty of the life of the organization
liability of the owner for his debts is unlimited
Types of Business Organizations
2. Partnership Ownership
• An association of two or more persons for the purpose of engaging in a business for
profit.
Advantages:
More capital may be obtained
Bound by few legal requirements as to its accounts, procedures, tax forms and other
items of operation
dissolution of the partnership may take place at any time by mere agreement of the
partners
provides an easy method whereby two or more persons different talents may enter
into business, each carrying those burdens that he can best handle
Disadvantages:
the amount of capital that can be accumulated is still limited
the life of the partnership is determined by the life of the individual partners.
there may be serious disagreement among the individual partners
each partner is liable for the debts of the partnerships
Types of Business Organizations
3. The Corporation
• A distinct legal entity, separate from the individual who own it, and which can
engage in almost any type of business transaction in which a real person could
occupy himself or herself.
Advantages:
enjoys perpetual life without regard to any change in the person of its owners, the
stockholders
the stockholders of the corporation are not liable for the debts of the corporation
easier to obtain large amounts of money for expansion
ownership in the corporation is readily transferred.
authority is easily delegated by the hiring of managers.
Disadvantages:
activities of a corporation are limited to those stated in its charter
complicated in formation and administration
greater degree of governmental control
Capitalization of a Corporation
The capital of a corporation is commonly acquired through the
sale of stocks.
Two principal types of capital stocks:
o Common Stock – represents ordinary ownership without special
guarantees of return
o Preferred Stock – guaranteed a definite dividend on their stocks.
Usually have the right to vote in meetings, but not always.
Preferred vs. Common
Feature Preferred Common
Ownership of Company Yes Yes
Voting Rights No Yes
Price of Security Is Based on: Earnings Earnings
Dividends Fixed Varies
Value if Held to Maturity Full Varies
Order Paid if Company Defaults First Second
Financing with Bonds
o A bond is a certificate of indebtedness of a corporation usually for
a period not less than ten years and guaranteed by a mortgage on
certain assets of the corporation or its subsidiaries.
o Bonds are issued when there is a need for more capital such as for
expansion of the plant or the services rendered by the corporation
o The face value of the bond is stated in the bond. When the face
value has been repaid, the bond is said to have been retired or
redeemed
o The bond rate is the interest rate quoted on the bond
Classification of Bonds
o Registered Bonds
- the name of the owner of this bond is recorded on the record books of the
corporation
- interest payments are sent to the owner periodically without any action
on his part
o Coupon Bonds
- have coupon attached to the bond for each interest payment that will
come due during the life of the bond
- the owner of the bond can collect the interest due by surrendering the
coupon to the offices of the corporation or at specified banks.
Bond Value
The value of a bond is the present worth of all future amounts that are
expected to be received through ownership of the bond. C
F => face value or par value Fr Fr Fr Fr Fr
Fr => interest on the bond per period
C => redemption or disposal price
r => bond rate per period 0
1 2 3 n-1 n
n => number of periods before redemption
i => investment rate or yield per period
P => value of the bond n periods before redemption
P
−𝒏
𝟏− 𝟏+𝒊 −𝒏
𝑷 = 𝑭𝒓 +𝑪 𝟏+𝒊
𝒊
Example
A bond issue of P200,000 in 10-year bonds, in P1,000 units,
paying 16% nominal interest in semiannual payments, must be
retired by the use of sinking fund that earns 12% compounded
semiannually. What is the total semiannual expense?
Example
A man wants to make 14% nominal interest compounded
semiannually on the bond investment. How much should the man
be willing to pay now for a 12% P10,000-bond that will mature in 10
years and pays interest semiannually?
Example
Mr. Romualdo bought a bond having a face value of P1,000 for
P970. The bond rate was 14% nominal and interest payments were
made to him semiannually for a total of 7 years. At the end of the 7th
year, he sold the bond to a friend at a price that resulted a yield of
16% nominal on his investment. What was the selling price?
Seatwork
A corporation sold an issue of 20-year bonds, having a total
face value of P10,000,000 for P9,500,000. The bonds bear
interest at 16%, payable semiannually. The company wishes to
establish a sinking fund for retiring the bond issue and will
make semiannual deposits that will earn 12%, compounded
semiannually. Compute the annual cost for interest and
redemption of these bonds.
