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Definition of Annual Report, Verbal and Data Section of Annual Report, Financial Statements given in an annual report, how does a corporation can raise its capital? Debt Financing versus Equity Financing, Financing a new project based on EPS
Annual ReportA report issued annually by a corporation to its stockholders is called annual report. An annual report is a brief profile on the health of a company.
Items in An Annual Report:01. Verbal Section• A letter/Speech from the chairman on the high points of business in the
past year with predictions for the next year. • Details Report/Company's philosophy: a section that describes how the
company does business. • An auditors' letter/Certificate confirming that all of the information
provided in the report is accurate and has been certified by independent accountants.
02. Data Section: Financial information:a. Income Statement: A company's income statement is a record of its
earnings or losses for a given periodb. Balance sheet: provides a snapshot of a firm’s financial position at one
point in time.c. Statement of retained earnings: shows how much of the firm’s earnings
were retained, rather than paid out as dividends.d. Statement of cash flows : reports the impact of a firm’s activities on cash
flows over a given period of time.
Debt Financing• Debt Financing: Debt financing means borrowing money that is to be
repaid over a period of time, usually with interest. Debt financing can be either short-term (full repayment due in less than one year) or long-term (repayment due over more than one year. In smaller businesses, personal guarantees are likely to be required on most debt instruments; commercial debt financing thereby becomes synonymous with personal debt financing. A type of Financing through the selling of a debt instrument is called Debt Financing.
• Advantages of Debt Financing: The biggest advantage of debt financing is that the lending party does not gain any part of ownership of the business and the only obligation of business to lending party is to repay the debt. Also, repayment of the loan is typically a fixed expense, according the terms of the loan.
• Disadvantages of Debt Financing: The biggest dis-advantage is that the business will not have all of its cash flow available to do business. Also, the interest that is owed can be high.
Equity Financing• Equity Financing: Equity financing describes an exchange of
money for a share of business ownership. This form of financing allows you to obtain funds without incurring debt; in other words, without having to repay a specific amount of money at any particular time. The major disadvantage to equity financing is the dilution of your ownership interests and the possible loss of control that may accompany a sharing of ownership with additional investors. Raising money for company activities by selling common or preferred stock to individual or institutional investors.
• Advantages of Equity Financing: The major advantage of equity financing is that the cash flow that would have been used to repay the loan, can be used to grow the business.
• Disadvantages of Equity Financing: The major disadvantage of equity financing is the loss of interest of ownership of your business and also the possible loss of complete control that can accompany a sharing of business ownership with investors.
Debt Financing vs Equity Financing
Grants ownership of the firm.Does not grant ownership of the firm.
Shareholders can share any upside or profits
Debt holders cannot share any upside or profits
Equity requires shared control of the company and may impose restrictions.
Debt has little or no impact on control of the company.
Dividend payments are not tax deductible.
Interest payments are tax deductible.
Equity providers are aggressive. Debt providers are conservative
No collateral required. Collateral assets must usually be available.
No payment requirements. May receive dividends, but only out of retained earnings.
Requires regular interest payments. Company must generate cash flow to pay.
Can usually be kept permanently. Must be repaid or refinanced. Equity FinancingDebt Financing
Elements of an Income statement
2011
Sales $1500Cost of Goods sold (1230)Gross Profit $270Fixed Operating expenses ($ 90)Depreciation ($ 50)Earnings before Interest & Taxes (EBIT) $ 130Interest Expense ($ 40)Earnings before Taxes (EBT) $ 90Taxes(@40%) ($ 36)Net income $ 54Preferred Dividend ($ 0 )Earnings available to common stockholders $ 54Common Dividends ($ 29) Addition to retain earnings $ 25Other DataNo. of Common Stocks 25Earnings per Share (EPS) $ 2.16Dividend Per Share (DPS) $ 1.16Stock price $ 23
2010
$1435(1176.7) $ 258.3
(85.0) (40)$ 133.3 (35.0)
98.3 (39.3)
$ 59 ($ 0)
$ 59 ( 27)$ 32.0
25$2.36$1.08
$23
Income statement
2011
Sales $1500Cost of Goods sold (1230)Gross Profit $270Fixed Operating expenses ($ 90)Depreciation ($ 50)Earnings Before Interest and Tax (EBIT) $ 130Interest ($ 40)Earnings Before Interest (EBT) $ 90Taxes(@40%) ($ 36)Net income $ 54Preferred Dividend ($ 0 )Earnings available to common stockholders $ 54Common Dividends ($ 29) Addition to retain earnings $ 25Other DataNumber of Common Stock 25Earnings Per Share (EPS) $ 2.16Dividend Per Share (DPS) $ 1.16Stock price $ 23
2012
2000$-------- ?????
(90) (100)
????? ($50)
? ? ? ? ? ? ? ?
?? ? ?($ 0)
???????(50% of NI)
? ? ? ? ?
30????????
$ 23
2012
2000($1230)
$ 770(90)
(100)$580
($ 50)$ 530
( 212) 318
($ 0)$318
($ 159)$ 159
30$10.6$ 5.3
$ 23
Example 01: Financing for a New Project
Your firm has outstanding $100,000 of 8% debt, 1,000 preferred stock paying a $10 annual dividend, and 5,000 common stock. It is considering raising $50,000 by either borrowing money at 9% or selling 5,000 additional shares of stock at $10 each. If "Bad Times" ensue, EBIT will be $30,000, while if "Good Times" occur, EBIT will be $75,000. The tax rate is 40%.
a.What is EPS under Debt financing during "Bad Times"?
b.What is EPS under Debt financing during "Good Times"?
c. What is EPS under Equity financing during "Bad Times"?
d. What is EPS under Equity financing during "Good Times"?
e. What type of Financing the firm should choose during Bad Times and During Good Times?
Data Analysis
Interest if Debt Financing Followed:Interest on already outstanding debt = $100,000 x .08 = $8,000Interest on new debt = $50,000 x .09 = $4,500 Total Interest on Debt = $ 12500
1.Preferred stock dividends = 1,000 shares x $10 per share = $10,000
2.During debt financing, common stock will not be increased.3.During Equity Financing, common stock will be increased4.During debt financing, total interest will be increased5.During equity financing, total interest remains unchanged.
Interest if Equity Financing Followed:Interest on already outstanding debt = $100,000 x .08 = $8000Interest on new debt = $0 Total Interest on Debt = $ 8000
Solution: a, b, c & d
$3.02$0.32$5.50$0.10EPS
100001000050005000÷ Number of Common Stocks
30200320027500500Earnings Available to Common Stock Holders
-10000-10000-10000-10000Less: Preferred Dividend
40200132003750010500Net Income
-26800-8800-25000-7000Less: Tax @ 40%
67000220006250017500EBT
-8000-8000-12500-12500Less: Interest
$75000$30000$75000$30000EBIT
Good Times
Bad Times
Good Times
Bad Times
Equity FinancingDebt Financing
e. Which Financing should be chosen?
Debt Financing
$ 3.02$ 5.50Good Times
Equity Financing$ 0.32$ 0.10Bad Times
Equity FinancingDebt Financing
Decision
EPS under
Situation
Example: Financing a New Project
Your firm has taken loan of Taka 500000 @15% from AB Bank. The Firm has to pay Preferred Dividend as Taka 100000 annually. It has 15,000 common stock. It is considering raising Taka 500,000 by either borrowing money at 14% or selling 5,000 additional shares of stock at Taka 100 each. If "Bad Times" ensue, EBIT will be $350,000, while if "Good Times" occur, EBIT will be $750,000. The tax rate is 35%. a.What is EPS under Debt financing during "Bad Times"?b.What is EPS under Debt financing during "Good Times"?c. What is EPS under Equity financing during "Bad Times"?d. What is EPS under Equity financing during "Good Times"?e. What type of Financing the firm should choose during Bad Times and During Good Times?
Example: Financing a New Project
Your firm has taken loan of Taka 200000 @15% from AB Bank and also Taka 300000 @ 16% from NCCB Bank. The Firm has 1,000 preferred stock paying a $10 annual dividend, and 15,000 common stock. It is considering raising Taka 500,000 by either borrowing money at 14% or selling 5,000 additional shares of stock at Taka 100 each. If "Bad Times" ensue, EBIT will be $350,000, while if "Good Times" occur, EBIT will be $750,000. The tax rate is 35%. a.What is EPS under Debt financing during "Bad Times"?b.What is EPS under Debt financing during "Good Times"?c. What is EPS under Equity financing during "Bad Times"?d. What is EPS under Equity financing during "Good Times"?e. What type of Financing the firm should choose during Bad Times and During Good Times?
Practice
Assume that you are working in a firm at this moment. Your firm has outstanding debt of Tk 50,000 paying interest @9.5%, 800 shares of preferred stock paying a Tk 10 annual dividend, and 5,000 shares of common stock. It is considering raising Tk 60,000 by either borrowing money at 10% or selling 6,000 additional shares of stock at Tk 10 each. If “Normal Situation" arise in economy, EBIT will be Tk 150,000, while if “Inflation" occur, EBIT will be Tk 90,000. The tax rate is 40%.
1.What type of financing your firm should have to choose Normal Economy situation? Why?
2.What type of financing your firm should have to choose during Inflation? Why?
Practice: Financing a New Project
Your firm has taken loan of Taka 800000 @13.5% from AIBL Bank and also Taka 1400000 @ 14.5% from City Bank. The Firm has 2,000 preferred stock paying a $10 annual dividend, and 20,000 common stock. It is considering raising Taka 10,00,000 by either borrowing money at 14% or selling 10,000 additional shares of stock at Taka 100 each. If "Bad Times" ensue, EBIT will be $350,000, while if "Good Times" occur, EBIT will be $750,000. The tax rate is 35%. a.What is EPS under Debt financing during "Bad Times"?b.What is EPS under Debt financing during "Good Times"?c. What is EPS under Equity financing during "Bad Times"?d. What is EPS under Equity financing during "Good Times"?e. What type of Financing the firm should choose during Bad Times and During Good Times?
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