How to Start Living a Debt Free Life

The Complete Debt Relief Manual

The Complete Debt Relief Manual is the best source of credit card debt elimination information you can find. It covers all aspects, in meticulous detail, of getting out of any form of debt, repairing your credit report, and rebuilding your credit. It even gives you step-by-step plans for dealing with creditors, collectors, lawsuits, bankruptcy, and the Irs. This book is a complete, step-by-step guide to debt freedom, from any angle. Discover the well-hidden secrets the credit card companies, credit card debt settlement services, collection agencies, the Irs, and the attorneys, Dont Want You TO Know! If you're battling debt problems, wondering how to eliminate your debts or repair your credit quickly, and you don't want to spend a fortune for help, learn to do it yourself. You will learn: The fastest way to achieve total credit card debt elimination. How to deal with creditors, collectors, attorneys, and the Irs. Why credit card debt settlement services are a Scam. How to negotiate credit card debt settlements. How to write a credit card debt settlement letter that gets results. How to avoid bankruptcy. How to declare Chapter 7 or Chapter 13 Bankruptcy (if you have to) How to rebuild bad credit. How to create simple budgeting sheets. More here...

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Cash is King in business a debt management guide from Lloyds TSB Commercial

Debt management is absolutely essential to the smooth running of any firm's finances. It begins when you first consider selling products or services to a client and finishes when full payment has been received from that particular customer. The first stage of any debt management process, before you even take the first order, is to research formally or informally, the business background of any significant new client or customer you're dealing with. Always follow up references from your customer's existing suppliers and before offering a line of credit, have a look at their track record by performing a credit check. It is also important to set, and stick to, an appropriate limit. Don't be tempted to increase that limit until the customer has built up a good track record and you should also ask for a purchase order with each request as some businesses will refuse to pay your invoice without one. Don't let emotions get in the way - maintain a businesslike tone in all letters. If a second...

Pay off your consumer debts

I repeat If you carry a balance on your credit card or have an outstanding auto loan, do not invest in mutual funds until these consumer debts are paid off. You won't be able to earn a consistently high enough rate of return in mutual funds to exceed the interest rate you're paying on consumer debt such as credit cards and auto loans. Although some financial gurus claim that they can make you 15 to 20 percent per year, they can't not year after year. Besides, in order to try and earn these high returns, you have to take great risk. If you have consumer debt and little savings, you're not in a position to take that much risk. I'll go a step further on this issue Not only should you delay any investing until your consumer debts are paid off, you should seriously consider tapping into any existing savings (presuming you would still have adequate emergency funds at your disposal) to pay off your debts.

Ask questions and avoid debt management programs

Probably the most important question to ask a counseling agency is whether it offers debt management programs (DMPs) where it puts you on a repayment plan with your creditors and gets paid a monthly fee for handling the payments. You do not want to work with an agency offering DMPs because of conflicts of interest. An agency can't offer objective advice about all your options for dealing with debt, including bankruptcy, if it has a financial incentive to put you on a DMP.

Valuation Of Longterm Debt Securities

Long-term debt securities, such as notes and bonds, are promises by the borrower to repay the principal amount. Notes and bonds typically To see how the valuation of future cash flows from debt securities works, let's look at the valuation of a straight coupon bond and a zero-coupon bond.

Trading consumer debt for mortgage debt

When you own real estate, you haven't borrowed the maximum, and you've run up high-interest consumer debt, you may be able to trade one debt for another. You may be able to save on interest charges by refinancing your mortgage or taking out a home equity loan and pulling out extra cash to pay off your credit card, auto loan, or other costly credit lines. You can usually borrow at a lower interest rate for a mortgage and get a tax deduction as a bonus, which lowers the effective borrowing cost further. Consumer debt, such as that on auto loans and credit cards, isn't tax-deductible. This strategy involves some danger. Borrowing against the equity in your home can be an addictive habit. I've seen cases where people run up significant consumer debt three or four times and then refinance their home the same number of times over the years to bail themselves out. An appreciating home creates the illusion that excess spending isn't really costing you. But debt is debt, and all borrowed money...

Debt service reserve letter of credit fac

The US 13.2 million debt service letter of credit facility, equal to six months principal and interest payments, supports temporary shortfalls in debt service payments to the 144A note holders. Drawings are available at whichever is the earlier date among the commercial operation date, the guaranteed completion date under the EPC contract or a 'date certain' - defined as 34 months plus allowable force majeure delays. Principal payments are subordinated to the other senior loans. The debt service reserve lenders have a right to 'step up' or upgrade their principal repayment status to be pari passu with all senior secured indebtedness if loans under the facility are not paid on time or if the project debt is accelerated. Fees and interest on the facility rank pari passu and share collateral with senior debt.

Contact Your Creditors or Get Credit Assistance

If you are having difficulty making your payments to your creditors on time, you should contact them. Tell them of your difficulties, but stress your intentions to pay them in full at a later date when you get your financial affairs back in order. Ask if they can stretch out your payments and waive interest and penalty fees until you can get on your feet again. If they agree, put it in writing so that it is more difficult for them to change their minds. If they will not agree, seek credit counseling from a nonprofit credit counseling service. The toll-free number of a national nonprofit credit counseling office is 800-388-2227. This office will refer you to a local office. You will meet with a counselor who will, for a small fee, devise a repayment plan. Counselors will also call or meet with your creditors to get their agreement on the plan. For the plan to work, all of your creditors must agree to it and you may be precluded from taking on any new debt. If the credit counseling...

P12-21 Eps And Optimal Debt Ratio Williams Glassware Has Estimated At Various Debt Ratios The Expected Earnings Per

Various capital structures Charter Enterprises currently has 1 million in total assets and is totally equity-financed. It is contemplating a change in its capital structure. Compute the amount of debt and equity that would be outstanding if the firm were to shift to each of the following debt ratios 10 , 20 , 30 , 40 , 50 , 60 , and 90 . (Note The amount of total assets would not change.) Is there a limit to the debt ratio's value EPS and optimal debt ratio Williams Glassware has estimated, at various debt ratios, the expected earnings per share and the standard deviation of the earnings per share as shown in the following table. v Debt ratio Earnings per share (EPS) . . Standard deviation of EPS . a. Estimate the optimal debt ratio on the basis of the relationship between earnings per share and the debt ratio. You will probably find it helpful to graph the relationship. b. Graph the relationship between the coefficient of variation and the debt ratio. Label the areas associated with...

Cash Flow To Debt Ratio

A variation on the formula is to ignore all short-term debt payments, on the grounds that the ratio is only intended to measure a company's long-term ability to meet its debt obligations. This version of the ratio is Though the ratio reveals that the Consortium has twice as much cash flow as there are debt payments to be met, the bank should be concerned about the continuing decline in the ratio over the past three years, because the Consortium has consistently added more debt in relation to the amount of cash it is generating. The bank may want to consider granting a loan with a short payback period so that it can get its money out quickly, before the ratio worsens further. Total long-term debt payments for the period Cash flow Debt payments Lease obligations Cash flow to debt ratio

Public Debt Management and the Government Securities Market9

Sovereign debt management is the process of establishing and executing a strategy for managing the government's debt in order to raise the required amount of funding achieve its risk and cost objectives, such as ensuring that the government's financing needs and its payment obligations are met at the lowest possible cost over the medium to long run, which is consistent with a prudent degree of risk and meet any other sovereign debt management goals that the government may have set, such as developing and maintaining an efficient market for government securities. Risky debt structures are often the consequence of inappropriate economic policies fiscal, monetary, and exchange rate but the feedback effects undoubtedly go in both directions. Poor structures in relation to the maturity profile and the interest rate and currency composition of the debt portfolio have often contributed to the severity of an economic and financial crisis. However, if macroeconomic policy settings are poor,...

The Effect of Debt Ratios on Costs of Capital

Debt Ratio, in Debt Ratio, in There can be an This chapter described the effect of these forces on the firm's value. But how do they change nterior O deW the firm's effective WACC In opposite directions the value and the cost of capital are mirrors of one another. Just think of the value of the firm today as the expected future cash flows of given projects, divided by one plus the cost of capital. Holding expected cash flows (projects) constant, when the firm's cost of capital increases, its present value decreases and vice versa. How does the firm's cost of capital look like as a function of its debt ratio You have already seen it in a perfect world (Figure 17.2) and in a world in which there were corporate income taxes (Figure 18.1). Figure 19.1 shows how it looks when there are multiple capital market imperfections, in which the optimal capital structure balances many forces. The cost of equity capital and the cost of debt capital both now are influenced by these forces. As drawn...

Example 183 Selecting the Debt Ratio That Leads to the Optimal Investment Strategy

The outside shareholders in Example 18.3 were able to induce the firm's managers to invest exactly the right amount by selecting the appropriate debt ratio. In reality, however, things may not work out as nicely. For one thing, Example 18.3 ignores the possibility that the firm also has internally generated funds to invest in the project. This does not necessarily cause a problem if the firm generates cash in those states of the

Case Problem 19 Do Multinational Firms Have Lower Debt Ratios than Domestic Firms

Authors of international finance textbooks have suggested a number of practical concepts. First, MNCs should support more debt in their capital structure than purely domestic companies. They point out that an MNC should have a higher target debt ratio than its domestic counterpart because of its size, access to capital markets, diversification, and tax concessions. The target debt ratio is the optimum capital structure, which is defined as the combination of debt and common equity that yields the lowest cost of capital. Second, MNCs should have lower business risk than purely domestic companies. Business risk, such as the cost of financial distress and expected bankruptcy cost, refers to the variability of operating profits or the possibility that the firm will not be able to cover its fixed costs. An MNC operates in many different countries and thus this diversification should translate into lower earnings volatility.

Working Capital To Debt Ratio

Description The working capital to debt ratio is used to see if a company could pay off its debt by liquidating its working capital. This measure is used only in cases where debt must be paid off at once, since the elimination of all working capital makes it impossible to run a business and will likely lead to its dissolution. The vice president uses this information to calculate the working capital to debt ratio 115,000 Workingcapital _ 185,000 Debt 62 Working capital to debt ratio

Optimal Debt Ratios based upon Comparable Firms

The predicted debt ratio from the regression shown above will generally yield (a) a debt ratio similar to the optimal debt ratio from the cost of capital approach (b) a debt ratio higher than the optimal debt ratio from the cost of capital approach (c) a debt ratio lower than the optimal debt ratio from the cost of capital approach dbtreg.xls There is a dataset on the web that summarizes the latest debt ratio regression across the entire market.

Going Public Effect on Optimal Debt Ratio

Would this information change your assessment of the optimal debt ratio a. It will increase the optimal debt ratio because publicly traded firms should be able to borrow more than private businesses b. It will reduce the optimal debt ratio because only market risk counts for a publicly traded firm c. It may increase or decrease the optimal debt ratio, depending on which effect dominates

Adjusting Wacc When Debt Ratios Or Business Risks Change

Suppose Sangria or the perpetual crusher project were all-equity-financed (D V 0). At that point WACC equals cost of equity, and both equal the opportunity cost of capital. Start from that point in Figure 19.1. As the debt ratio increases, the cost of equity increases, because of financial risk, but notice that WACC declines. The decline is not caused by use of cheap debt in place of expensive equity. It falls because of the tax shields on debt interest payments. If there were no corporate income taxes, the weighted-average cost of capital would be constant, and equal to the opportunity cost of capital, at all debt ratios. We showed this in Chapters 9 and 17. Figure 19.1 shows the shape of the relationship between financing and WACC, but we have numbers only for Sangria's current 40 percent debt ratio. We want to recalculate WACC at a 20 percent ratio. Step 2 Estimate the cost of debt, rD, at the new debt ratio, and calculate the new cost of equity. Let's do the numbers for the...

Debt Ratios

The debt position of a firm indicates the amount of other people's money being used to generate profits. In general, the financial analyst is most concerned with long-term debts, because these commit the firm to a stream of contractual payments over the long run. The more debt a firm has, the greater its risk of being unable to meet its contractual debt payments. Because creditors' claims must be satisfied before the earnings can be distributed to shareholders, current and prospective shareholders pay close attention to the firm's ability to repay debts. Lenders are also concerned about the firm's indebtedness.

Debt Service Funds

As discussed in Chapter 15, the function of the general long-term debt account group is to provide a record of the unredeemed principal of long-term liabilities incurred to acquire general fixed assets. Closely related to this account group are debt service funds, whose primary function is to account for financial resources accumulated to cover the payment of principal and interest on general government obligations. As in other governmental funds, the modified accrual basis is used for recognizing revenues, other financing sources, and expenditures in debt service funds. Interest and principal on general

Debt Ratio

The debt ratio indicates how much of the financing of the total assets comes from debt. The ratio is calculated as follows Debt ratio -- A company with a large debt ratio becomes increasingly vulnerable if there is a downturn in sales and or the economy, particularly in the latter case, if it is a cyclical company.

Alternative Asset Class

Alternative assets, then, are just alternative investments within an existing asset class. Specifically, most alternative assets derive their value from either the debt or equity markets. For instance, most hedge fund strategies involve the purchase and sale of either equity or debt securities. Additionally, hedge fund managers may invest in derivative instruments whose value is derived from the equity or debt markets. In this book, we classify five types of alternative assets hedge funds, commodity and managed futures, private equity, credit derivatives, and corporate governance. Hedge funds and private equity are the best known of the alternative asset world. Typically these investments are accomplished through the purchase of limited partner units in a private limited partnership. Commodity futures can be either passive investing tied to a commodity futures index, or active investing through a commodity pool or advisory account. Private equity is the investment strategy of...

Financial Markets and Financial Instruments

Chapter 2, devoted to understanding debt securities and debt markets, emphasizes the wide variety of debt instruments available to finance a firm's investments. However, the chapter is also designed to help the reader understand the nomenclature, pricing conventions, and return computations found in debt markets. It also tries to familiarize the reader with the secondary markets in which debt trades. Chapter 3 covers equity securities, which are much less diverse than debt securities. The focus is on the secondary markets in which equity trades and the process by which firms go public, issuing publicly traded equity for the first time. The chapter examines the pricing of equity securities at the time of initial public offerings and introduces the concept of market efficiency, which provides insights into how prices are determined in the secondary markets.

See Chapters 4 8 9 and

For a given corporation with a fixed overall capitalization, a move to a higher debt-to-equity ratio will have two immediate effects. First, the earnings will be reduced by the amount of the debt service (after the appropriate tax impact), and second, the equity base will be reduced by the debt claim on the total book of assets. These effects lower both the numerator and the denominator of the P E ratio, so that it is not immediately clear what the net impact would be, either in magnitude or direction. In fact, it turns out that, depending on the specific firm's characteristics, increasing leverage can move the P E ratio either higher or lower. However, for the level of leverage typically encountered in nonfinancial firms (i.e., up to 50 to 60 of total capitalization), the P E effect is quite modest, regardless of direction. 2. It is important to distinguish this very moderate bidirectional effect of leveraging a given company from the problem of an investor trying to evaluate a group...

Some Examples of the Conflict

Existing bondholders can be made worse off by increases in borrowing, especially if these increases are large and affect the default risk of the firm, and these bondholders are unprotected. The stockholders' wealth increases concurrently. This effect is dramatically illustrated in the case of acquisitions funded primarily with debt, where the debt ratio increases and the bond rating drops significantly. The prices of existing bonds fall to reflect the higher default risk.16

Topics Covered In This Book

As you work through these chapters, you may have some basic questions about financing. For example, What does it mean to say that a corporation has issued shares How much of the cash contributed at arrow 1 in Figure 1.1 comes from shareholders and how much from borrowing What types of debt securities do firms actually issue Who actually buys the firm's shares and debt individual investors or financial institutions What are those institutions and what role do they play in corporate finance and the broader economy Chapter 14, An Overview of Corporate Financing, covers these and a variety of similar questions. This chapter stands on its own bottom it does not rest on previous chapters. You can read it any time the fancy strikes. You may wish to read it now.

Appendix Direct Estimates Of The Productivity Of Rdthe Model

Rt R& D expenditures, Kt capital investment, dt payments to shareholders in the form of dividends and net share repurchases, bt interest and net debt payments, at acquisitions net of asset sales. d < 0, b < 0, a < 0 mean respectively that a new equity is raised in the form of capital contributions from equityholders, net bond issues exceed interest and debt repayments, and asset sales exceed acquisitions. plus stock repurchases plus the ending value of the interest payments plus debt payments

National and Private Debt

The American consumer also has been busy spending at rates that are the highest in 20 years. These figures include mortgage debt, home equity loans, and secondary mortgages totaling 10 trillion, and consumer debt of 2 trillion. No wonder Wal-Mart is doing so well and China is directly benefiting at the same time.

Macroeconomic Conditions and Financial Innovation

Occasionally, conditions that influence the macroeconomy, such as oil prices or inflation, lead to innovative debt securities. For example, during the 1989 Kuwaiti crisis, crude oil prices skyrocketed to about 40 per barrel although long-term oil prices, represented by prices in the forward market, were far lower. Several firms were convinced by their investment banks that it was a good time to issue oil-linked bonds. Such bonds were characterized by lower than normal coupon rates, allowing the corporate issuer to save on interest payments. To compensate investors for the low coupon rate, the principal to be paid was either four times the per-barrel price of crude oil at the maturity of the bond or 100, whichever was larger. Salomon Brothers was one firm that showed its corporate clients how to hedge the oil price risk of the principal payment by entering into forward contracts for oil.

Filing for Bankruptgy

Financial troubles have led millions of Americans to file for bankruptcy, often using the process as an alternative. How wrong. Filing for bankruptcy is the last resort to your financial woes, not a choice. If you are in debt and need to file, however, there are pitfalls you can avoid. Chapter 7 is used mainly if you have unsecured debts. For example, if you have furniture or appliances as unpaid collateral, you can return these without paying for them. But if you want to keep these things, you might be allowed a reaffirmation agreement with your creditors. Also, attorneys' fees are set so you can establish an installment plan.

Long Term Solvency Measures

Total Debt Ratio The total debt ratio takes into account all debts of all maturities to all creditors. It can be defined in several ways, the easiest of which is Total debt ratio Prufrock has .28 in debt for every 1 in assets. Therefore, there is .72 in equity ( 1 - .28) for every .28 in debt. With this in mind, we can define two useful variations on the total debt ratio, the debt-equity ratio and the equity multiplier A Brief Digression Total Capitalization versus Total Assets Frequently, financial analysts are more concerned with the firm's long-term debt than its short-term debt, because the short-term debt will constantly be changing. Also, a firm's accounts payable may be more of a reflection of trade practice than debt management policy. For these reasons, the long-term debt ratio is often calculated as Long-term debt ratio To complicate matters, different people (and different books) mean different things by the term debt ratio. Some mean a ratio of total debt, and some mean a...

Financial institutions and Markets

Governments maintain deposits of temporarily idle funds, certain tax payments, and Social Security payments in commercial banks. They do not borrow funds directly from financial institutions, although by selling their debt securities to various institutions, governments indirectly borrow from them. The government, like business firms, is typically a net demander of funds It typically borrows more than it saves. We've all heard about the federal budget deficit.

Playing the credit card float

Given what I have to say about the vagaries of consumer debt, you may think that I'm always against using credit cards. Actually, I have credit cards, and I use them but I pay my balance in full each month. Besides the convenience credit cards offer me in not having to carry around extra cash and checks I receive another benefit I have free use of the bank's money until the time the bill is due. (Some cards offer other benefits, such as frequent flyer miles, and I have one of those types of cards too. Also, purchases made on credit cards may be contested if the sellers of products or services don't stand behind what they sell.)

Summary and Conclusions

This chapter has provided an introduction to the various sources of debt financing bank loans, leases, commercial paper, and debt securities. A large variety of debt financing is available. In addition, there are many ways to categorize debt instruments by their covenants, options, cash flow pattern, pricing, maturity, and rating. assets. Accomplishing this goal requires a substantial amount of knowledge about debt securities, some of which is found in this chapter. kets. These skills are useful to the corporate manager who needs to determine whether to finance an investment with debt securities or equity securities.

Is there Another Wave of American Decline

It is no secret that US economic expansion in the 1990s had been sustained with money borrowed abroad. American companies accrued huge debts, often to buy back company shares. American consumer debt is enormous and continues to grow, with no end in sight. In addition, the spending boom has generated record trade deficits, including 500 billion in 2002. To finance current-account deficits, the USA has been forced to borrow approximately 2 billion every working day, most of which comes from foreign investors. Japanese and other foreign investors continue to fund the US economy even today (see figure 3.1), but the boom in the US economy and its stock market ended in 2000. In addition, nobody thinks that this kind of inflow can be sustained indefinitely as war and terrorism fears mount, a change that may boost the inflation rate and hurt corporate profits, the US dollar, and investment returns. The financial reversal would also bring about the collapse of US security policy and of its...

Real Estate and the Mortgage Money Market

There 's roughly 2.5 trillion in outstanding mortgages, some of which are known as subprime mortgages, which financed credit for homeowner buyers with high debt or poor credit and some of which are called Alternative-A mortgages, which are made up of not-quite-primetime debtors. These mortgages provided these two classes of homebuyers with new adjustable-rate mortgages as a means to distribute the new supply of money, thanks to the Fed 's liberal monetary policy. Experts anticipate that as much as 1 trillion of these mortgages will default in 2007. In the coming years, adjustable-rate mortgage payments could go sky high if mortgage holders cannot roll over their mortgages to an improved fixed rate. A wave of foreclosures could still be on the horizon. In fact, the prediction by experts is that there will be a couple million foreclosures in the next 18 to 24 months. The mortgage money market has taken a big hit with this one. If you have a lot of cash, such as what occurs when you want...

Having access to credit

Sometimes it may seem as though lenders are trying to give away money by making credit so easily available. But this free money is a dangerous illusion. Credit is most dangerous when you make consumption purchases you can't afford in the first place. When it comes to consumer debt (credit cards, auto loans, and the like), lenders aren't giving away anything except the opportunity for you to get in over your head, rack up high interest charges, and delay your progress toward your financial and personal goals.

Foreclosing on the American Dream Mortgage Finance and Housing

As Figure 2.6 on page 51 shows, between the first quarter of 2001 and the first quarter of 2007, total mortgage debt in the United States doubled from 4.92 trillion to 9.96 trillion. As for mortgage origination, that had tripled from 1997 levels to reach a total of 2.5 trillion in the year 2006 alone (see pp. 112-119). United States banks, in the meantime, were moving into mortgage finance in a big way. Figure 2.2 on page 32 shows the mushrooming of the percentage of total bank earning assets that fell into the mortgage-related category. From some 28 percent in 1985, the ratio jumped to 40 percent in 1989, about 50 percent in 1998, and some 60 percent in 2006. Banks, and brokerage firms with them, were placing a whopping bet.

Managing the balancing act

Although I cover practical solutions to common financial quandaries later in this book, I also discuss the more touchy-feely side of money. For example, some people who continually rack up consumer debt have a spending addiction. Other people who jump in and out of investments and follow them like a hawk have psychological obstacles that prevent them from holding on to investments.

Present Value With State Contingent Payoff Tables

Almost all companies and projects are financed with both debt and levered equity. You already know what debt is. Levered equity is simply what accrues to the business owner after the debt is paid off. (In this chapter, we shall not make a distinction between financial debt and other obligations, for example tax obligations, and we will not cover different control rights. This is left to Part IV.) You already have an intuitive sense about this distinction. If you own a house with a mortgage, you really own the house only after you have made all debt payments. If you have student loans, you yourself are the levered owner of your future income stream. That is, you get to consume your residual income only after your liabilities (including your nonfinancial debt) are paid back. But what will the levered owner and the lender get if the company's projects fail, if the house collapses, or if your career takes a turn towards Rikers Island What is the appropriate compensation for the lender and...

Financial Soundness Indicators

Earnings and profitability Debt service capacity Foreign exchange risk Household debt service and principal payments to Debt service capacity Indicates a household's ability to cover its debt payments Corporate sector indicators tend to focus on indicators of leverage (or gearing), profitability, liquidity, and debt-servicing capacity because of those indicators' demonstrated usefulness in predicting corporate distress or failure.13 Four commonly used measures of corporate sector health are the debt-to-equity ratio, the return on equity, the cash ratio, and the debt service coverage (or interest coverage ratio). Total debt to equity measures leverage or the extent to which activities are financed out of other than own funds. High corporate leverage increases the vulnerability of corporations to shocks and may impair their repayment capacity. Return on equity is commonly used to capture profitability and efficiency in using capital. Over time, it can also provide information on the...

The Primary Market New Issues

Most debt securities are traded in dealer markets. The many bond dealers communicate with one another by telecommunications equipment wires, computers, and telephones. Investors get in touch with dealers when they want to buy or sell, and can negotiate a deal. Some stocks are traded in the dealer markets. When they are, it is referred to as the over-the-counter (OTC) market.

The Jones Family Incorporated

Marsha Don't worry dear, it will be over soon. We only recalculate our most efficient common stock portfolio once a quarter. Then you can go back to leveraged leases. John You trade, and I do all the worrying. Now there's a rumor that our leasing company is going to get a hostile takeover bid. I knew the debt ratio was too low, and you forgot to put on the poison pill. And now you've made a negative-NPV investment Marsha What investment

Current assets debtors

Having offered your customer credit, the objective is to ensure that the credit terms are met. This is achieved by regularly checking the age-debt list and chasing overdue debtors through telephone and e-mail. If gentle reminders fail to get payment, the next step is to advise the customer that credit is suspended and that further orders will be considered on a 'cash with order' basis only. If that fails to achieve the objective, then debt collection agencies and the courts can be used as a last resort. The problem about using debt collection agencies and the courts is that you will incur costs that will not be recoverable if the debtor cannot pay as against wilfully refuses to pay. As lawyers will tell you 'It is pointless suing a man of straw.' So again a review of the customer's accounts is recommended before committing to additional costs.

Saving for Big Purchases

Paying for high-interest consumer debt can cripple your ability not only to save for long-term goals but also to make major purchases in the future. Interest on consumer debt is exorbitantly expensive upwards of 20 percent on credit cards. When contemplating the purchase of a consumer item on credit, add up the total interest you'd end up paying on your debt and call it the price of instant gratification.

The Great 2008 Bailout Shrewdness Or Neohooverism

Hoover, they pointed out, was an activist, a man famous for his humanitarian food relief leadership during the World War era. As president in 1929, he criticized his party's laissez-faire wing, later prodding the Federal Reserve Board to expand credit and businessmen to maintain wage levels. By 1931, he was proposing a global moratorium on First World War debt payments and gaining Congressional approval for an unprecedented federal-level Reconstruction Finance Corporation. In the words of historian William Leuchtenburg, He advocated legislation to undergird mortgages and to liberalize requirements for the issue of Federal Reserve notes. Today, these measures seem modest, but, at the time, BusinessWeek called the law to ease credit 'perhaps

Cash Is King Estimating Cash Flows

The value of an asset comes from its capacity to generate cash flows. When valuing a firm, these cash flows should be after taxes, prior to debt payments and after reinvestment needs. There are thus three basic steps to estimating these cash flows. The first is to estimate the operating income generated by a firm on its existing assets and investments. While you can obtain an estimate of this from the income statement, the accounting income has to be substantially adjusted for technology firms to yield a true operating income. The second is to estimate the portion of this operating income that would go towards taxes. will investigate the difference between effective and marginal taxes at this stage, as well as the effects of substantial net operating losses carried forward. The third is to develop a measure of how much a firm is reinvesting back for future growth. While this reinvestment will be divided into reinvestment in tangible and long-lived assets (net capital expenditures) and...

Credit Card Nation The Economics of Manic Consumption

We can begin with national consumption, which ultimately intensified to represent an appalling seven-tenths of the U.S. economy. It drove debt, and vice versa. Between 1960 and 1980, household debt rose from 50 percent of GDP to 60 percent, still below the binge ratios of the 1920s. Then in the 1980s, consumer debt alone more than doubled, and by the early 2000s, the escalation was frightening.

Overview of Debt Markets

Table 7-1 breaks down the world debt securities market, which was worth 38 trillion at the end of 2001. This includes the bond markets, defined as fixed-income securities with remaining maturities beyond one year, and the shorter-term money markets, with maturities below one year. The table includes all publicly tradable debt securities sorted by country of issuer and issuer type as of December 2001. TABLE 7-1 Global Debt Securities Markets - 2001 (Billions of U.S. dollars) TABLE 7-1 Global Debt Securities Markets - 2001 (Billions of U.S. dollars)

Understanding how you gain

If you have the savings to pay off consumer debt, like high-interest credit card and auto loans, consider doing so. (Make sure you pay off the loans with the highest interest rates first.) Sure, you diminish your savings, but you also reduce your debts. Although your savings and investments may be earning decent returns, the interest you're paying on your consumer debts is likely higher. jjjjftBE Paying off consumer loans on a credit card at, say, 12 percent is like finding an investment with a guaranteed return of 12 percent tax-free. You would actually need to find an investment that yielded even more around 18 percent to net 12 percent after paying taxes in order to justify not paying off your 12-percent loans. The higher your tax bracket (see Chapter 7), the higher the return you need on your investments to justify keeping high-interest consumer debt. Even if you think that you're an investing genius and you can earn more on your investments, swallow your ego and pay down your...

Balance Sheet Analysis

Balance sheet ratios aid the analyst in assessing a firm's liquidity, asset management, and debt management policies, each of which is discussed in this section. Debt Management Ratios The most inclusive and most useful debt management ratios are the composition ratios drawn from a vertical analysis of the right side of the balance sheet. Note the liability and equity composition ratios in the right-hand column of Exhibit 3-4. These percentage composition ratios indicate the relative proportions of various forms of debt and owners' equity used to finance the organization. The ratio of total debt to total assets, also called the debt-to-assets ratio, is often used as a primary indicator of the firm's debt management. Exhibit 3-4 shows that Sample Company's total liabilities are equal to 58.2 of total assets. As this key ratio increases or decreases, it indicates the firm's changing reliance on borrowed resources. The lower the ratio, the lower the firm's risk because the organization...

Merger And Acquisition Activity In The Recent Past

In January 2004, American Airlines and JetBlue Airways emerged as contenders to purchase the Boston-New York-Washington shuttle service from an ailing US Airways. Since its bankruptcy in 2003, US Airways has struggled to emerge from its severe financial troubles. Competition with discount providers makes this struggle to recover even more difficult. JetBlue, a three-year-old, low-fare airline has experienced success and is looking for an opportunity to expand.18 In spite of the post-September 11, 2001 slump in air travel, JetBlue has managed to prosper and is seeking rapid expansion.

Government Debt Placement

44 Responsibility for the regulation of banks and other financial institutions was given to the newly formed Financial Services Authority, bound by the Financial Services and Markets Act (2000). The 1998 Bank of England Act makes the Bank responsible for price stability but it also has a division focused on the reduction of systemic risk and undertaking official operations to prevent contagion. A Memorandum of Understanding (Appendix 5 of the 1998 Act) makes the Bank of England, the FSA and the Treasury jointly responsible for financial stability. The 1998 Act also transfers responsibility for the management of government debt from the Bank of England to an executive agency of government, the Debt Management Office. Treasury officials set the agenda for the Chief Executive of the DMO in the annual Debt Management Report. See Blair (1998).

More On Bond Features

Securities issued by corporations may be classified roughly as equity securities and debt securities. At the crudest level, a debt represents something that must be repaid it is the result of borrowing money. When corporations borrow, they generally promise to make regularly scheduled interest payments and to repay the original amount borrowed (that is, the principal). The person or firm making the loan is called the creditor, or lender. The corporation borrowing the money is called the debtor, or borrower.

Long Term Debt The Basics

Ultimately, all long-term debt securities are promises made by the issuing firm to pay principal when due and to make timely interest payments on the unpaid balance. Beyond this, there are a number of features that distinguish these securities from one another. We discuss some of these features next. The maturity of a long-term debt instrument is the length of time the debt remains outstanding with some unpaid balance. Debt securities can be short-term (with maturities of one year or less) or long-term (with maturities of more than one year).1 Short-term debt is sometimes referred to as unfunded debt.2 Debt securities are typically called notes, debentures, or bonds. Strictly speaking, a bond is a secured debt. However, in common usage, the word bond refers to all kinds of secured and unsecured debt. We will therefore continue to use the term generically to refer to long-term debt.

Equity Debt and Cost of Capital for Banks

There is also a practical problem in computing the cost of capital for a bank. If we define debt as any fixed commitment where failure to meet the commitment can lead to loss of equity control, the deposits made by customers at bank branches would qualify and the debt ratio of a bank will very quickly converge on 100 . If we define it more narrowly, we still are faced with a problem of where to draw the line. A pragmatic compromise is to view only long term bonds issued by a bank as debt, but it is an artificial one. Deutsche Bank, for instance, had long-term debt in December 2003 was 82 billion Euros, common equity with a market value of 40.96 billion Euros and preferred stock with a market value of 4.1 billion Euros. Using the cost of equity of 8.76 (from illustration 4.11), the after-tax cost of debt of 3.13 from illustration 4.12 and the cost of preferred stock (6.36 ) from illustration 4.13

Based On The Balance Sheets Given For Bethesda Mining Calculate The Following Financial Ratios For Each Year

Return on Equity. Schism, Inc has a total debt ratio of 0.70, total deb of 265,000. and net income of S24.850. What is the company's return on equity 27. Ratios and Fixed Assets. The Hooya Company has a long-term debt ratio (i.e., the ratio of long-term debt to long-term debt plus equity) of 0.60 and a current ratio of 1.3. Current liabilities are 900, sales are 6,590, profit margin is 9 percent, and ROE is 16 percent. What is the amount of the firm's net fixed assets

The Rainbow Company Has Net Income Of 132500.

A fire has destroyed a large percentage of the financial records of the Inferno Company. You have the task of piecing together information in order to release a financial report. You have found the return on equity to be 16.5 percent. Sales were 1,625,000, the total debt ratio was 0.30, and total debt was 648,000. What is the return on assets (ROA)

Determinants of Bond Ratings

The bond ratings assigned by ratings agencies are primarily based upon publicly available information, though private information conveyed by the firm to the rating agency does play a role. The rating that is assigned to a company's bonds will depend in large part on financial ratios that measure the capacity of the company to meet debt payments and generate stable and predictable cashflows. While a multitude of financial ratios exist, table 3.2 summarizes some of the key ratios that are used to measure default risk

Making The Numbers Talk

A conspicuous feature of Boston Beer's income statement is the absence of interest expense, reflecting the company's debt-free balance sheet. This characteristic eliminates one source of earnings volatility fluctuations in interest rates.1 (Note that even if a company confines its borrowings to fixed-rate debt, its interest expense is variable in the sense that the company may replace maturing debt with higher-cost or lower-cost debt as a consequence of changes in interest rates.) For most beverage producers (and for companies in the industrial sector, generally), rising and falling interest rates have only a limited effect on the earnings. They are not invariably debt-free, but interest expense typically represents a minor portion of their total costs. Changes in interest rates have a dramatic impact, however, on banks and finance companies which have cost structures heavily concentrated in interest expense.

Implementing the methodology

As in corporate defaults, sovereign default on a debt service payment puts the total debt outstanding in default through pari passu and cross default clauses that are routinely written into the debt contracts. In practice, once default has occurred and the government has demonstrated its willingness to suffer the costs this entails, a bargaining process begins, usually within the Paris and London Clubs, whereby the government enters negotiations with its creditors to trade the value of the exercised default option by recommencing payments in exchange for concessions such as forgiveness, reschedulings, etc. Our analysis is limited to the initial decision to default.

Difficulties In The Interpretation Of Crosssection Data

Does large personal indebtedness deter consumers from buying durable goods, from further borrowing, and from depleting their liquid reserves Given their incomes and their other circumstances, are consumers more likely to make net reductions in their indebtedness and to curtail their spending when their existing debt is large than when it is small Are they more likely to borrow, and to buy durable goods, when they are relatively debt free Answers to these questions would greatly contribute to an appraisal of the economic consequences of a given volume of consumer debt. If the answers are affirmative, a high ratio of debt to income would have to be interpreted as a deflationary sign, an indication that consumer spending

Answers challenge problems

Bond covenants are discussed furrher in the debt securities topic reviews. Higher interest costs will increase WACC, making some borderline projects unviable. Agency relationships costs present are likely to be affected in some way by the adverse change in credit rating.

The Role of Financial Ratios

I've been looking into that, the financial manager replies. Our current debt ratio is .3. If we borrow the full cost of the project, the ratio would be about .45. When we took out our last loan from the bank, we agreed that we would not allow our debt ratio to get above .5. So if we borrow to finance this project, we wouldn't have much leeway to respond to possible emergencies. Also, the rating agencies currently give our bonds an investment-grade rating. They too look at a company's leverage when they rate its bonds. I have a table here (Table A.16) which shows that, when firms are highly leveraged, their bonds receive a lower rating. I don't know whether the rating agencies would downgrade our bonds if our debt ratio increased to .45, but they might. That wouldn't please our existing bondholders, and it could raise the cost of any new borrowing.

Earnings Analysis and Adjustments 000

Be removed, because the cash flows are first adjusted to a debt-free basis. As shown in Figure 6.4, the 2004 working capital as a percentage of revenue is selected as an appropriate level for future requirements. Debt-Free Data Net Income (Debt Free) Cash Flow (Debt Free)

Basel Amendment 199617 Market Risk

As defined in Chapter 3, market risk is the risk that changes in market prices will cause losses in positions both on- and off-balance sheet. The ''market price'' refers to the price of any instrument traded on an exchange. The different forms of market risk recognised in the amendment include equity price risk (market and specific), interest rate risk associated with fixed income instruments,19 currency risk and commodities price risk. Debt securities (fixed and floating rate instruments, such as bonds, or debt derivatives), forward rate agreements, Whether the Amendment raises or lowers the capital charge of a bank depends on the profile of its trading book. However, as will be shown below, banks using the ''standardised'' approach are likely to incur higher capital charges, unless positions are well hedged or debt securities are of a high investment grade.20 Under the Amendment, one of two approaches to market risk can be adopted, internal models or standardised.

What are some potential pitfalls of ratio analysis based on accounting data

Interest Rate Long Terms Chat

Long-term debt ratio Debt-equity ratio Total debt ratio a. Long-term debt ratio b. Total debt ratio c. If the firm must retire 300,000 of debt for the sinking fund each year, what is its fixed-payment cash-coverage ratio (the ratio of cash flow to interest plus other fixed debt payments) 19. Leverage. A firm has a long-term debt-equity ratio of .4. Shareholders' equity is 1 million. Current assets are 200,000 and the current ratio is 2.0. The only current liabilities are notes payable. What is the total debt ratio Long-term debt ratio .4 1 Nothing will happen to the long-term debt ratio computed using book values, since the face values of the old and new debt are equal. However, times interest earned and cash coverage will increase since the firm will reduce its interest expense.

Currency Choices and NPV

In the analysis above, the cashflows that we discounted were prior to interest and principal payments and the discount rate we used was the weighted average cost of capital. In NPV parlance, we were discounting cashflows to the entire firm (rather than just its equity investors) at a discount rate that reflected the costs to different claimholders in the firm to arrive at a net present value. There is an alternative. We could have discounted the cashflows left over after debt payments for equity investors at the cost of equity and arrived at a net present value to equity investors. Given that the two approaches yield the same net present value, which one should we choose to use Many practitioners prefer discounting cashflows to the firm at the cost of capital, because it is easier to do, since the cashflows are before debt payments and we do not therefore have to estimate interest and principal payments explicitly. Cashflows to equity are more intuitive, though, since most of us think...

Stockholders and Bondholders

(2) Restrict dividend policy In general, increases in dividends increase stock prices while decreasing bond prices, because they reduce the cash available to the firm to meet debt payments. Many bond agreements restrict dividend policy, by tying dividend payments to earnings.

The picture as of 1998

First, an infrastructure project such as a power plant that generates local-currency revenues in a developing country can be financed 'out of the box' with bonds under the right circumstances. In this case, the sponsors were of top quality Colombia at that time had an investment-grade credit rating and the alternate standby facility and debt service reserve were additional financing tools to bridge timing problems. Third, debt-service reserve facilities require careful risk analysis. Issues include Thomas E. Lake noted that in the subordination 'waterfall' interest payments and fees rank pari passu with senior debt. If a payment under a debt-service reserve facility is delayed, the lenders have the right to raise the status of those overdue obligations to the senior debt level. In Lake's opinion it is important for bankers to understand and properly explain these structures. Generally, for a debt-service reserve facility sponsors are willing to pay a slight spread over the rate for...

Sovereign Bond Ratings

The implication of this is that the factors S& P analyzes in assessing the creditworthiness of a national government's local currency debt and foreign currency debt will differ to some extent. In assessing the credit quality of local currency debt, for example, S& P emphasizes domestic government policies that foster or impede timely debt service. The key factors looked at by S& P are as follows Maturity structure and debt service burden Debt service track record Public debt burden and debt service track record.

IAS 39 Financial Instruments Recognition and Measurement

The Group's interest-bearing debt includes floating-interest bank debt of DKK 919m (2001 1,270m). Contracts to hedge future interest payments have not been entered. The fixed-rate debt totals DKK 387m (2001 DKK l44m).The fixed-interest mortgage debt totals DKK 68m (2001 DKK 73m).The average effective rate of interest relating to the interest-bearing debt was 6.0 in 2002.

Behind the Numbers Fixed versus Variable Costs

Exhibit 3.8 presents the fictitious case of West Coast Whatsit. The top graph plots the company's reported unit sales volume versus pretax income for each of the past 10 years. (West Coast is debt-free and has no other non-operating income or expenses, so the company's operating income is equivalent to its pretax income.) Observe that the plotted points are concentrated in the upper right-hand corner of the graph, reflecting that annual sales

Financial Statement Analysis

Financial statement analysis is the process of examining relationships among financial statement elements and making comparisons with relevant information. It is a valuable tool used by investors and creditors, financial analysts, and others in their decision-making processes related to stocks, bonds, and other financial instruments. The goal in analyzing financial statements is to assess past performance and current financial position and to make predictions about the future performance of a company. Investors who buy stock are primarily interested in a company's profitability and their prospects for earning a return on their investment by receiving dividends and or increasing the market value of their stock holdings. Creditors and investors who buy debt securities, such as bonds, are more interested in liquidity and solvency the company's short- and long-run ability to pay its debts. Financial analysts, who frequently specialize in following certain industries, routinely assess the...

Financial systems the evidence

The aggregate data for the 1980s (Table 3.12(a), for seven of our economies, and Table 3.12(b) for nine of them) and the 1970s and 1980s (Table 3.12(c), for four of them) confirm some of the contrasts we have drawn. The US and the UK are more than 60 per cent dependent on retentions and shares in both periods, and have ratios of debt to total equity below 2, as does Switzerland. Two of the three 'stakeholder' economies, Sweden and Japan, were less than 50 per cent dependent on retentions and shares for net financing in the 1980s. Sweden and Japan both got more than 30 per cent of their net financing from bank loans, as did Japan in 1970-1989. Both had high debt equity ratios, Sweden's more than three times that of any of the shareholder economies. The big surprise is Germany. The German figures for the 1980s are less disaggregated than the others but they still indicate a striking deviation from the stakeholder pattern retentions plus shares contribute more than even in the US and UK....

The Dollar and the US Balance of Payments

The overvaluation of the dollar and the collapse of the high-tech boom, which had boosted exports of ITC equipment, took their toll on US exports which lost one-fifth of their world market share between 2000 and 2003. The growing current account deficit reflected a growing deficit in goods and even the services account declined a little to near balance in the early 2000 s. By 2004 the debts of the US government and firms overseas exceeded US-owned foreign assets by the equivalent of some 30 of its GDP. Even so it was still making a small net surplus on the returns from its investments overseas, much of which had constituted high return 'direct' investments by US companies with subsidiaries overseas. Though there was a big inflow of direct investment into the USA in the 1980s and especially during the new economy boom, a good deal of this was invested in taking over existing US assets, yielding a lower return than US multinationals earned on their direct investments abroad in new...

Determine Your Debt Capacity

The amount left over when monthly cash disbursements are subtracted from monthly receipts is the amount available for debt payments. If disbursements are greater than receipts, you cannot afford to take on any new debt, as you will not be able to pay the interest and principal payments without drawing down on your assets. Not everything is as simple or clear-cut as this first approach suggests, which leads to a second approach for determining whether you can afford to take on debt. This approach involves analyzing your budget to determine where potential trade-offs may lie. By forgoing spending in some areas, you can increase the amount available to finance debt payments. Cutting vacation and entertainment expenses, for example, can free up funds for servicing debt, but it becomes progressively harder to cut down on necessary types of expenses. The rule of thumb of a 20 percent ceiling on the amount of debt payments to monthly disposable income is a useful guideline. This means that...

How the financing was arranged

Bear Stearns was engaged by InterGen before the banks were. InterGen wanted to do a bond financing 'out of the box', but recognised that this was an ambitious undertaking and therefore developed a backup plan in case the bond markets turned unfavourable. This requirement led to the idea of an alternate standby facility to serve as an insurance policy. InterGen tendered the standby letter of credit facility and the debt service working capital reserve facility to the banks for bids. Dresdner Kleinwort Benson arranged the standby facility, receiving approval from their respective credit committees to underwrite a syndicated loan for the full amount, but did not actually underwrite the facility because it was not needed.

The intertemporal budget constraint means that the current stock of debt should equal the present value of future

The intertemporal budget constraint has huge implications. It implies that countries with high debt are either going to have to default or run tighter fiscal policy in the future. If a country has very good growth prospects, it can expect to be able to repay its The intertemporal budget constraint tells us why it is problematic to have similar numerical targets for debt levels across countries. Debt sustainability means that, on the basis of existing government policies, the future will see sufficient fiscal surpluses to pay back current debt. Different countries have different future prospects and so should have different current levels of debt. Countries where future growth will be high can afford to have larger stocks of government debt than those where growth will be lower. Mature, developed countries cannot confidently expect future growth to be higher than the average over the past few decades. The implication is that, for mature economies who are unlikely to experience...

Challenge 17 Problems

By refusing credit to firms with a poor credit score (worse than 80) Galenic calculates that it would reduce its bad debt ratio to 60 9,160, or just under .7 percent. While this may not seem like a big deal, Galenic's credit manager reasons that this is equivalent to a decrease of one-third in the bad debt ratio and would result in a significant improvement in the profit margin. which implies that p .909. The break-even probability is higher because the profit margin is now lower. The firm cannot afford as high a bad debt ratio as before since it is not making as much on its successful sales. We conclude that high-margin goods will be offered with more liberal credit terms.

Debt Equity Ratio and Return on Equity

Exhibit 6-1 clearly demonstrates the risks and rewards that companies experience as they increase their levels of debt. The reward is an improved return on equity. The risk is higher interest expense and debt service requirements that become increasingly difficult to meet. Companies with very predictable, high-quality earnings can afford a high debt equity ratio, especially if they have considerable fixed assets to provide collateral for the loans. Economic conditions and current events aside, examples are commercial real estate and power utilities. Start-up and Internet companies generally have no earnings at all, or at best very erratic earnings. They generally do not qualify for loans from financial institutions.

O 114 The International Bond Market

The international capital market consists of the international bond market and the international equity market. Table 11.3 shows selected indicators at year-end 2001 on the size of the capital markets around the world. Several inferences can be drawn from this table. First, the world's stock market capitalization was almost as big as the world's gross domestic product (GDP). Second, the US GDP was only 1.4 times as big as the combined GDP of some 130 emerging market countries, but its stock market capitalization was 7.1 times as big as the combined stock market capitalization of these emerging market countries. Third, G-5 countries (the USA, Japan, Germany, the UK, and France) accounted for 61 percent of the world's GDP, 71 percent of the world's total equity market capitalization, and 75 percent of the world's total debt securities.

Power Purchase Agreement

Emcali purchases power from the facility under a 20-year dispatchable PPA, with fixed capacity payments and variable energy payments. The capacity payments are designed to cover all fixed operating costs, including debt service and return on investment. The energy payments pass through actual fuel-supply and transport costs and other variable operating expenses. TermoEmcali's tariffs are US dollar-indexed. Under the PPA, tariffs are protected from a change in law. Emcali sells power into the Bolsa when dispatched by the national dispatch centre and directly to unregulated customers under contracts. At the end of the first 20 years the project's ownership will be transferred to Emcali without additional consideration.

The international bond market size and its currency denomination

Table 11.4 shows that the outstanding amount of international debt securities reached a historical high of 10,266 billion in 2003. Eurobonds account for approximately 70 percent of the international bond market, whereas foreign bonds and global bonds account for only 30 percent of the market. Industrial countries account for approximately 85 percent of the international bond market, while developing countries accommodate the remaining 15 percent of the market. Table 11.4 Outstanding amounts of international debt securities (billions of US dollars) Table 11.4 Outstanding amounts of international debt securities (billions of US dollars)

How to Manage Your Debt

If you find that you are not saving any money because most of your income is tied up in debt, or you are having to juggle your payments to service your debt payments on time, you have a problem. You should address your debt problem before it progresses to the point of your having to declare bankruptcy.

Ordinary Americans A New And Growing Risk Burden

The economic uncertainty and disillusionment of Middle America has become a commonplace. The five-year stagnation of median family incomes, the additional millions lacking health insurance coverage, and the increasing share of personal income required for debt service have taken the wind out of the sails of even new-economy soothsayers. If household-sector risk consciousness had a quantifier, it would be at or near a record. Figure 4.1 (page 100) displays Warren's assessment of how rising basic costs mortgage, child care, health insurance, car, and taxes have been consuming more and more of the discretionary remainder of family income. By a different but overlapping calculus, the percentage of household disposable income spent on debt service principally mortgage, auto loan, and credit card debt had risen from just over 10 percent in 1983 to 14.5 percent in 2006.5 The sort of households that preoccupied Hacker and Warren simply did not enjoy flush times in the early years of the new...

Financial Sector Legal Framework

Bank laws, banking insurance and capital market laws, etc.), as well as the broader legal framework underpinning the payments system, government debt management, and other infrastructure elements (such as insolvency regime, creditor and land rights, corporate governance, and consumer protection). The scope and coverage of those components of the legal framework are outlined below.

The Consequences of Debt Irrelevance

Debt Ratio Debt Ratio The value of the firm is also unaffected by the amount of leverage it has. Thus, if the firm is valued as an all-equity entity, its value will remain unchanged if it is valued with any other debt ratio. (This actually follows from the implication that the cost of capital is unaffected by changes in leverage and from the assumption that the operating cash flows are determined by investment decisions rather than financing decisions.)

Inflationary Biases in Interest Costs

Most firms raise some of their capital by issuing fixed-income assets such as bonds and bank loans. This borrowing leverages the firm's assets since any profits above and beyond the debt service go to the stockholders. In an inflationary environment, nominal interest costs rise, even if real interest costs remain unchanged. But corporate profits are calculated by deducting nominal interest costs, which overstates the real interest costs to the firm. Hence, reported corporate profits are depressed compared to true economic profits.

Financing Mix based on Comparable Firms

Firms often try to use a financing mix similar to that used by other firms in their business. With this approach, Bookscape would use a low debt to capital ratio because other book retailers have low debt ratios. Bell Atlantic, on the other hand, would use a high debt to capital ratio because other phone companies have high debt to capital ratios. The empirical evidence about the way firms choose their debt ratios strongly supports the hypothesis that they tend not to stray too far from their sector averages. In fact, when we look at the determinants of the debt ratios of individual firms, the strongest determinant is the average debt ratio of the industries to which these firms belong. While some would view this approach to financing as contrary to the approach where we trade off the benefits of debt against the cost of debt, we would not view it thus. If firms within a business or sector share common characteristics, it should not be surprising if they choose similar financing...

Legal and Regulatory Issues

We have already touched on some of the legal issues regarding non-competition agreements, non-disclosure agreements, and proper filings for the issuance of equity and debt securities. In addition, the venture capitalist must also determine if patent protection is needed for the start-up's proprietary intellectual property, and if so, initiate the legal proceedings.

Why do Developing Nations Demand External Finance

External finance comes in a number of different forms short and long-term private and official loans made by foreign banks governments, foreign direct investment and portfolio investments, consisting of debt securities (private or state backed bonds and other securities issued by the LDC) and equity, acquired when non-residents purchase shares on the LDC's After Mexico defaulted on its debt in 1982, Brazil and other countries soon followed. Between 1980 and 1993, 64 developing nations experienced problems repaying their sovereign external debt and negotiated multilateral debt relief agreements totalling 6.2 billion. In the late 1980s and early 1990s, global banks began to increase their exposure in emerging markets, though sovereign loans were largely replaced by the use of debt securities and equities. Thus, the early 1990s (as in many previous years) saw a net financial transfer towards emerging market economies, peaking at 66 billion in 1993. However, in December 1994, Mexico was...

The Approach And The Data

A survey of the consumer debt position of a sample of households at the beginning and end of a year provides an opportunity for statistical analysis of variables associated with the size of a household's consumer debt and with the amount and direction of change in that debt during the year. The objective of such analysis is to assist in the estimation of stable economic behavioral relationships which can serve as tools in forecasting and in assaying the effects of alternative policies. As will become amply clear in the course of the paper, this objective is a difficult one to achieve the results of statistical analysis of cross-section data are likely to be susceptible to a variety of possible interpretations. Still the attempt must be made the ambiguities of econometric analysis of aggregate time series are, if anything, even greater than those confronting the analyst of cross sections of individual economic units. To avoid this kind of pitfall, the approach of the analyst of survey...

Steps in Applying Operating Income Approach

Given the probability distribution of operating cash flows and the debt payments, we can estimate the probability that the firm will be unable to make those payments. 4. We set a limit on the probability of its being unable to meet debt payments. Clearly, the more conservative the management of the firm, the lower this probability constraint will be. The average change in operating income on an annual basis over the period was 10.09 , and the standard deviation in the annual changes is 19.54 . If we assume that the changes are normally distributed, these statistics are sufficient for us to compute the approximate probability of being unable to meet the specified debt payments. ( 2,713- 1747 million) (.1954 * 2713) 1.82 Based upon the t statistic, the probability that Disney will be unable to meet its debt payments in the next year is 3.42 . Step 5 Since the estimated probability of default is indeed less than 5 , Disney can afford to borrow more than 5 billion. If the distribution of...

Theoretical Example Of A Leveraged Buyout

The 700 million LBO is financed with 600 million in debt (with a 10 coupon rate) and 100 million in equity. The company must pay yearly debt service of 60 million to meet its interest payment obligations. After the LBO, the management of the company improves its operations, streamlines its expenses, and implements better asset utilization. The result is that the cash flow of the company improves from 80 million a year to 120 million a year.5 By foregoing dividends and using the free cash flow to pay down the existing debt, the management of the company can own the company free and clear in about seven years.

Limitations of the Operating Income Approach

Although this approach may be intuitive and simple, it has some drawbacks. First, estimating a distribution for operating income is not as easy as it sounds, especially for firms in businesses that are changing and volatile. For instance, the operating income of firms can vary widely from year to year, depending upon the success or failure of individual products. Second, even when we can estimate a distribution, the distribution may not fit the parameters of a normal distribution, and the annual changes in operating income may not reflect the risk of consecutive bad years. This can be remedied by calculating the statistics based upon multiple years of data. For Disney, in the above example, if operating income is computed over rolling two-year periods3, the standard deviation will increase and the optimal debt ratio will decrease This approach is an extremely conservative way of setting debt policy because it assumes that debt payments have to be made out of a firm's cash balances and...

Independent engineers report

In the independent engineer's report Stone & Webster concluded that the facility would be able to achieve and maintain operating standards specified in the PPA that projected operating results were a reasonable forecast of the project's economics and that projected debt service coverage ratios were insensitive to reasonable changes in technical assumptions. The independent engineer considered liquidated damages to be adequate, but also recommended giving the contractor an incentive to achieve the guaranteed completion date. Stone & Webster noted that the power plant site was easily accessible and located next to a substation of the gas pipeline. Its riverside location simplified construction. Stone & Webster was commissioned to provide an ongoing review throughout the life of the project.

Capital Structure The Optimal Financial

In this chapter, we explore three ways to find an optimal mix. The first approach begins with a distribution of future operating income we can then decide how much debt to carry by defining the maximum possibility of default we are willing to bear. The second approach is to choose the debt ratio that minimizes the cost of capital. Here, we review the role of cost of capital in valuation and discuss its relationship to the optimal debt ratio. The third approach, like the second, also attempts to maximize firm value, but it does so by adding the value of the unlevered firm to the present value of tax benefits and then netting out the expected bankruptcy costs. The final approach is to base the financing mix on the way comparable firms finance their operations.

The Role of Cost of Capital in Investment Analysis and Valuation

In order to understand the relationship between the cost of capital and optimal capital structure, we first have to establish the relationship between firm value and the cost of capital. In chapter 5, we noted that the value of a project to a firm could be computed by discounting the expected cash flows on it at a rate that reflected the riskiness of the cash flows, and that the analysis could be done either from the viewpoint of equity investors alone or from the viewpoint of the entire firm. In the latter approach, we discounted the cash flows to the firm on the project, i.e., the project cash flows prior to debt payments but after taxes, at the project's cost of capital. Extending this principle, the value of the entire firm can be estimated by discounting the aggregate expected cash flows over time at the firm's cost of capital. The firm's aggregate cash flows can be Assume that you are given the costs of equity and debt at different debt levels for Belfan's, a leading...

Steps in the Cost of Capital Approach

We need three basic inputs to compute the cost of capital - the cost of equity, the after-tax cost of debt and the weights on debt and equity. The costs of equity and debt change as the debt ratio changes, and the primary challenge of this approach is in estimating each of these inputs. Let us begin with the cost of equity. In chapter 4, we argued that the beta of equity will change as the debt ratio changes. In fact, we estimated the levered beta as a function of the debt to equity ratio of a firm, the unlevered beta and the firm's marginal tax rate Plevered Punlevered 1+(1-t)Debt Equity Thus, if we can estimate the unlevered beta for a firm, we can use it to estimate the levered beta of the firm at every debt ratio. This levered beta can then be used to compute the cost of equity at each debt ratio. estimate a firm's dollar debt and interest expenses at each debt ratio as firms increase their debt ratio, both dollar debt and interest expenses will rise. Second, at each debt level,...

Paying off highinterest debt

Many folks have credit card or other consumer debt that costs more than 10 percent per year in interest. Paying off this debt with savings is like putting your money in an investment with a guaranteed return that's equal to the rate you're paying on the debt. For example, if you have credit card debt outstanding at 14 percent interest, paying off that loan is the same as putting your money to work in an investment with a sure 14 percent annual return. Remember that the interest on consumer debt is not tax-deductible, so you actually need to earn more than 14 percent investing your money elsewhere in order to net 14 percent after paying taxes. (See Chapter 5 for more details if you're still not convinced.) Paying off some of or your entire mortgage may make sense, too. This financial move isn't as clear as erasing consumer debt, because the mortgage interest rate is lower than it is on consumer debt and is usually tax-deductible. (See Chapter 14 for more details on this strategy.)

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