Long Term Financing Paper Final
Running head: Long-Term Financing
Long-Term Financing
University of Phoenix Online
Introduction to Finance and Accounting
MMPBL-503
James R. Sullivan
November 3, 2008
Long-Term Financing An established company is considering expanding its operations, and to achieve their business objectives, the company will require additional long-term capital financing. Long-term financing involves debt or equity instruments with greater than one-year maturities, and the cost of this long-term capital can be calculated using either the Capital Asset Pricing (CAPM) or Discounted Cash Flows (DCFM) Model. The organization will have to compare and contrast the Capital Asset Pricing Model with the Discounted Cash Flows Model. The skill of comparing and contrasting financial options will help evaluate and organize the debt/equity mix and dividend policy. The organization must then decide what type of long-term finance alternatives will most likely benefit.
Capital Asset Pricing Model and the Discounted Cash Flows Model Capital Asset Pricing Model is a linear relationship between returns on individual stocks and stock market returns over time (Block & Hirt, 2005). One use of CAPM is to analyze the performance of mutual funds and other portfolios (CAPM, 2008). Although, more than one formula exists for the CAPM, the most common is referred to as the market risk premium model presented below (Block & Hirt, 2005): r = Rf + beta (Km – Rf) Where: r is the expected return rate on a security Rf = the risk free rate of return (cash) B = beta coefficient, or historical volatility of common stock relative to market index Km = is the return rate of the appropriate asset class The market risk premium formula assumes that the rate of return or premium demanded by investors is directly proportional to the perceived risk associated with the common stock. Beta
Long-Term Financing
University of Phoenix Online
Introduction to Finance and Accounting
MMPBL-503
James R. Sullivan
November 3, 2008
Long-Term Financing An established company is considering expanding its operations, and to achieve their business objectives, the company will require additional long-term capital financing. Long-term financing involves debt or equity instruments with greater than one-year maturities, and the cost of this long-term capital can be calculated using either the Capital Asset Pricing (CAPM) or Discounted Cash Flows (DCFM) Model. The organization will have to compare and contrast the Capital Asset Pricing Model with the Discounted Cash Flows Model. The skill of comparing and contrasting financial options will help evaluate and organize the debt/equity mix and dividend policy. The organization must then decide what type of long-term finance alternatives will most likely benefit.
Capital Asset Pricing Model and the Discounted Cash Flows Model Capital Asset Pricing Model is a linear relationship between returns on individual stocks and stock market returns over time (Block & Hirt, 2005). One use of CAPM is to analyze the performance of mutual funds and other portfolios (CAPM, 2008). Although, more than one formula exists for the CAPM, the most common is referred to as the market risk premium model presented below (Block & Hirt, 2005): r = Rf + beta (Km – Rf) Where: r is the expected return rate on a security Rf = the risk free rate of return (cash) B = beta coefficient, or historical volatility of common stock relative to market index Km = is the return rate of the appropriate asset class The market risk premium formula assumes that the rate of return or premium demanded by investors is directly proportional to the perceived risk associated with the common stock. Beta
References: Ask Dr Econ. (2008) " Federal Reserve Bank of San Francisco:What are the differences between debt and equity markets?" Retrieved October 31, 2008 from http://www.frbsf.org/education/activities/drecon/answerxml.cfm?selectedurl=/2005/0510.html Block, S. B., & Hirt, G. A., (2005). Foundations of Financial Management (11th ed.). New York: McGraw-Hill. Capital Asset Pricing Model, (2008). Retrieved October 31, 2008, from http://www.moneychimp.com/glossary/capm/htm. Capital Asset Pricing Model Limitations, (2008). Retrieved October 31, 2008, from http://www.fina.ngwingchi.com/?p=35 Discounted Cash Flow Limitations. (2008). Retrieved October 31, 2008, from http://ocw.mit.edu/nr/rdonlyres/sloan-school-of-management/15-535business-analysis-using-financial. Freeman, G.R. & Gagne, M., (1992). An Investigation of the Usefulness of Cash Flows: The Effect of Firm Size. Journal of Applied Business Research. Raymond, JD PhD. Michael T. (2002)"Financing Instruments: ZeroMillion Articles." Retrieved October 31, 2008 from http://www.zeromillion.com/business/ten/financing.html Spors, Kelly. (2008, October 7). Small Talk. Wall Street Journal. Retrieved from http://online.wsj.com/article/SB122333708661309651.ht Utility Regulation. (2006). Retrieved October 31, 2008 from http://utilityregulation.com