Question

Please answer the following:

Q.No. 01. Justify the following comments in just a paragraph or two: a Callable preference Stock is good option for the company. b. Market rate of interest played vital role in Issuance of Bonds c. Debt Financing is good for the company instead of Equity Financing d. Book Value and EPS are the indicators, which are true representation of financial performance and Financial Position of the company.

Answer 1

Answer-:

a) Callable preferred stock is a type of preferred stock in which the issuer has the right to call in or redeem the stock at a pre-set price after a defined date. Callable preferred stock terms, such as the call price, the date after which it can be called, and the call premium (if any) are all defined in the prospectus.

Redeemable preferred stock, also known as callable preferred stock, is a popular means of financing for large companies, combining the elements of equity and debt financing.

A callable preferred stock issue offers the flexibility to lower the issuer's cost of capital if interest rates decline or if it can issue preferred stock later at a lower dividend rate. For example, a company that has issued callable preferred stock with a 7% dividend rate will likely redeem the issue if it can then offer new preferred shares carrying a 4% dividend rate. The proceeds from the new issue can be used to redeem the 7% shares, resulting in savings for the company.

b)  It may seem strange at first but interest rates and bond prices move in the opposite direction, impacting the market value of investments.

When interest rates rise, the market value of bonds falls.

If you have a bond with a coupon of 3% and the cash rate increases from 3% to 4%, for example, the coupon rate on the bond will now seem less attractive to investors so they’ll be willing to pay less for it.

The market price of long term bonds may be more volatile than shorter term bonds, because changes to the relative rate of return would have a bigger impact over a longer period of time.

A lower price, however, would improve the current yield for perspective investors because if they can buy the bond for a discount, their overall return will be higher.

If interest rates decline, bond prices will rise. That’s because more people will want to buy bonds that are already on the market because the coupon rate will be higher than on similar bonds about to be issued, which will be influenced by current interest rates.

If you have a bond with a coupon rate of 3% and the cash rate falls from 3% to 2%, for example, then you and other investors might wish to hold onto the bond as the rate of interest has improved on a relative basis.

c)  Debt financing may offer its own hidden benefits over equity financing. Here are five reasons to justify it-:

1. In the long run, debt is cheaper than equity

Entrepreneurs tend to think of VC as free money. It’s not. In fact, if you plan to scale and exit, debt is almost always the cheaper option.

Think of it this way. If you take a five-year loan of $1M at 20% APR, that $1M has cost you $1.6M by the time you pay it off. But if you take $1M from a VC at a $5M valuation (meaning you sell 20% of your equity), then get acquired for $15M, those VCs get $3M.

The same amount of capital at the same time, but the lender sells you $1M for $1.6M, and the VC sells you $1M for $3M.

2. Debt gives you tax benefits

Assuming your company is out of the red, debt financing provides a few tax perks that equity financing cannot.

If your business uses accrual accounting, the interest portion of your payment runs through your profit and loss statement, which reduces your taxable net income. This means the effective cost of the borrowing is less than the stated rate of interest. Essentially, the US government helps mitigate the cost of your loan.

3. A lender isn’t going to tell you how to run your business

Taking on equity investors means giving them seats on your board. It also means conforming to their expectations of how your company should grow. If you don’t like it, be careful—they can limit your control over the business you started, or, in the worst-case scenario, oust you from your own company.

Lenders don’t worry as long as you’re hitting your payments and staying in a position to continue doing so. No board seats, no control.

4. For businesses with sticky revenue streams, debt can be very accretive

Jason Lemkin points out that if you’re an early-stage company with recurring revenue streams (like SaaS or subscription-based services), a minor amount of debt will actually increase your net cash flows. The extra cash will let you make a few key hires. If you hire well, those folks will build out features and sales programs and you can see an ROI much higher than the cost of their salaries.

5. More time to actually run your company

Raising a VC round usually takes between six and nine months of coffee meetings, pitches, and phone calls. Raising debt financing is generally much faster. Lighter Capital, where I work, often funds companies in one month.

Debt saves you time once you get it, too. Lenders don’t need to keep up with your every decision, and they don’t require board meetings. They won’t need to deliberate with you over every new hire or strategy.

d)  The math for earnings per share (EPS) seems simple enough: Divide net income by the number of shares outstanding. That's it. But at least five variations of EPS are being used these days, and an investor needs to understand what each represents in order to make informed decisions about stocks.

The EPS announced by a company may differ significantly from what is reported in its financial statements and in the headlines. Depending on the EPS used, a stock may appear overvalued or undervalued.

Carrying value per share, more commonly referred to as the book value of equity per share (BVPS), measures the amount of company equity in each share. This measure focuses on the balance sheet and not much else, so it is a static representation of company performance.

Nevertheless, the general trend of this number suggests how effective management is at increasing shareholder equity. The current BVPS should tell the investor how much a share would be worth if the company had to be liquidated and all of its assets sold.

Notably, Benjamin Graham and Warren Buffett consider BVPS to be one of the most important company measures.

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