Corporate financing

ECE472 — Engineering Economic Analysis and Entrepreneurship

Two main mechanisms for corporate financing:

• Corporate debt via bonds — borrow money, pay interest each year, pay it back at the end.
  • The cost of debt financing $k_d$ is a percentage: the interest on principal.
• Equity via shares — sell part of ownership, give a share of profit (either via dividends or share price appreciation).

Corporate debt

• borrow money
• pay interest each year
• pay it back at the end
• risk premium
• cost of debt financing $k_d$: interest on principal

Bonds

• legal obligation enforced by the court — bondholder has right to get money back
• if you default → then bankruptcy → sell assets → get cash → pay bondholders

Equity

• sell part of ownership
• share of profit (Dividends, share price appreciation)
  • dividends: return is based on revenue — variable profit
  • for ex. if company makes 15% in revenue relative to company worth, for a share price of 100, then dividend pay out might be 15\
• voting rights (a say in running the company)
• cost of equity financing $k_e$: percent: dividend per year / share price

in general: debt is more predictable than equity for investors equity more expensive but less risky for company debt less expensive, more risky for company (bc legal obligations)

cost of capital $k$ used as MARR. is weighted average percentage cost

$$k=\frac{D}{V}{k}_D+\frac{E}{V}{k}_E$$

$D$ debt $E$ equity $V$ money raised $V=D+E$

usual capital structure to minimise $k$ is around 20%