Business Financing & Capital Valuation Methods
Key Capital & Valuation Concepts
Opportunity Cost of Capital
The value an investor foregoes when choosing not to invest in comparable projects.
Financing Modalities
- Internal: Financial resources belonging to the company (shareholder equity).
- External: Outside resources that generate debt (liabilities).
Share Valuation Methods
- Nominal Value: The value assigned to the title at issuance.
- Accounting Value: Owner’s equity divided by the number of shares.
- Market Value: The price at which stock is sold in the market.
- Intrinsic Value: Net Present Value (NPV) of the cash flows related to an investment in shares.
Business Bank Financing Options
Short-Term Bank Financing
Short-Term Loans
Provided by financial institutions. The company receives an amount of capital (i.e., principal) that must be returned within a determined period. Additionally, the company must pay interest and other fees. Interest is usually expressed as an annual rate (%), which can be fixed or variable.
Line of Credit
A financial institution allows the client (i.e., the borrower) to borrow up to a maximum limit. The borrower must pay interest only on the amount actually borrowed. In some cases, the client also has to pay a fee on the undrawn amounts. The main advantage of a line of credit is its built-in flexibility; however, this is often offset by a higher interest rate.
Commercial Discount
The bank lends the company the amount of a Bill of Exchange or a Promissory Note. (These documents prove that a third party owes the company a certain amount.) The company receives this amount from the bank, before the maturity date of the promissory note, minus a certain interest expense.
Factoring (Non-Recourse)
The company sells, prior to maturity, the amount credited to customers to an external service company (the ‘factor’). The factor will collect the money and assume the risk of non-payment. The factor charges a fee (i.e., interest), but the company can improve its liquidity and reduce administrative costs.
Credit & Debit Cards
The issuing entity advances money to the merchant and charges a financing fee for the risk of collection and administration. Alternatively, similar financing methods are now offered, such as PayPal, Mobypay, etc.
Long-Term Bank Financing
Long-Term Loans
Provided by financial institutions. The company receives an amount of capital (i.e., principal) that must be returned over a determined period. Additionally, the company must pay interest and other fees. Interest is usually expressed as an annual rate (%), which can be fixed or variable.
Finance Lease (Capital Lease)
- It is a lease contract where the lessor leases an asset (for almost its entire lifespan) to a lessee for an agreed lease fee.
- When the contract expires, the lessee has three options: they can buy the asset at its residual value, the contract can be renewed, or if neither of these is chosen, the lessee must return the asset to the lessor.
Characteristics of Finance Leases
- It is a type of secured financing, similar to a mortgage guarantee.
- Capital leases are regarded as essentially equivalent to a sale by the lessor and a purchase by the lessee (even though the title remains with the lessor). Therefore, leased assets must be shown in the lessee’s balance sheet as a fixed asset with a corresponding non-current liability (lease payable). The lessee must depreciate the leased asset like any other fixed asset.