Business Finance

Governor Pack Road, Baguio City, Philippines 2600

Tel. Nos.: (+6374) 442-3316, 442-8220; 444-2786;
442-2564; 442-8219; 442-8256; Fax No.: 442-6268 Grade Level/Section: Grade 12- ABM
Email: email@uc-bcf.edu.ph; Website: www.uc-bcf.edu.ph

MODULE 6 – FINANCE Subject Teacher: Kenny Jones A. Amlos

Long-term FINANCING
Learning objectives:
At the end of this module, students must be able to:
1. discuss long-term financing;
2. identify sources of long-term funds;
3. describe the cost of long-term funds as a source of financing; and
4. solve problems and make recommendations involving long-term financing.

CONTENTS:

Financial resources – funds of a business which are provided by the owner of by the creditors. The
source of fund is considered long-term when the repayment period is more than one year
notwithstanding the normal operating cycle of the business. However, in this discussion, long-term
connotes a term of five years or more. A term of more than one year but not more than five years is
referred to as medium-term.

Financial Structure – the mixture of current assets

and fixed assets.
Capital Structure – the mixture of long-term liabilities
and capital (equity).
• purely from long-term creditors
• purely from owners or stockholders
• combination of both

Sample problem no. 1:

Lamp has projected sales of ₱100,000, a gross profit margin of 45%, a return on sales of 15%. Accounts
receivable has been 25% of sales while inventory has been 10% of cost of sales. Lamp has minimum
cash balance of ₱10,000 and fixed assets are projected to be ₱75,000. With this type of financial
structure, determine the required total assets.
Solution:
Cash ₱ 10,000
Accounts receivable (0.25 x P100,000) 25,000
Inventory (0.1 x P100,000 x 0.55) 5,500
Fixed assets 75,000
Total assets required ₱115,500

Trust Fund Doctrine – requires that funds provided by the stockholders protect the interest of the
creditors.
Financial Leverage – means the business has more funds like bonds and long term bank borrowings
coming from long-term creditors in the capital structure.
Debt-free of unlevered capital structure – indicates that the owners provide almost all financial
requirements of the business, both the working capital needs and the fixed assets requirements.

Factors affecting capital structure decision:

1. Business risk – refers to the amount of risk that is inherent in the operation of the business. Level
of business risk is highly influenced by the following:
a. Demand variability
b. Sales price variability
c. Cost variability
d. Ability to adjust sale prices for changes in costs
e. Level of operating leverage
Operating leverage – refers to the extent to which the business uses fixed cost in its
operation.

Business Finance Page 1 of 4

 Business Finance
Governor Pack Road, Baguio City, Philippines 2600
Tel. Nos.: (+6374) 442-3316, 442-8220; 444-2786;
442-2564; 442-8219; 442-8256; Fax No.: 442-6268 Grade Level/Section: Grade 12- ABM
Email: email@uc-bcf.edu.ph; Website: www.uc-bcf.edu.ph

MODULE 6 – FINANCE Subject Teacher: Kenny Jones A. Amlos

2. Firm’s tax position – When the firm’s fixed assets are financed by bonds or long-term bank
borrowings, the interest payments will lower the net income, thereby lowering the income tax.
But if this continue, the payment of interests may eat up the operating income of the business.
3. Financial flexibility – refers to the ability of the business to raise long-term funds when needed.
4. Managerial Inclination – Different perspective of managers as to sourcing funds. Some
managers are risk-takers and prefer to use long-term debts to finance the fixed assets of the
business. This will require a high rate of return coupled with a high financial risk.

Sources of Long-term funds:

a) Long-term debts
• Bonds – an unconditional promise to pay a specified sum of money at a determinable
future time with the periodic interest based on stated interest.
• Bank borrowings – usually supported by promissory note. The Omnibus Credit Line is an
example of long-term borrowing.

b) Preference (preferred) shares – shares of stocks in which the holder enjoys higher preference or
rights over the holder of an ordinary share in terms of distribution of dividends and assets in case
of corporate dissolution and liquidation.

c) Ordinary (common) shares - shares of stocks in which the holder does not enjoy preference as
to distribution of dividends and assets. Ordinary shareholders on the other hand have the right
to vote during stockholders’ meeting.

d) Retained earnings – the accumulated profits, losses, and adjustments of a corporation. The
retained earnings is composed of the unappropriated portion (unrestricted) and appropriated
portion (restricted).

Costs of LONG-TERM funds:

The determination of cost of long-term funds is a financial management topic referred to as Capital
Budgeting. This involves determining whether or not to commit a significant amount of long-term funds
to projects whose usefulness is spread over several periods.

Cost of capital – the minimum or lowest acceptable rate of return that the business may earn from
alternative investments. The formula to calculate cost of capital are:

Cost of Debt (after tax) =

𝑲𝒊 = 𝑲𝒅 (𝟏 − 𝒕)
Where:
ki = After-tax cost of debt
kd = Pre-tax cost of debt
t = tax rate

Sample problem no. 2:

Bagsik Corporation is planning to issue ₱220,000,000 bonds at an effective interest rate of 10%. The
company pays income tax at a rate of 30%. Determine the cost of debt capital.
Solution:
𝑲𝒊 = . 𝟏𝟎 (𝟏−. 𝟑𝟎)
= .07 or 7%

Cost of preference shares =

𝑫𝑷
𝑲𝑷 =
(𝑷𝑷 − 𝑭)
Where:
kp = Cost of preference shares
Dp = Dividend per share
Pp = Market value per preference share
F = Floatation cost (amount to be paid to investment bankers to sell the stocks)
Business Finance Page 2 of 4
 Business Finance
Governor Pack Road, Baguio City, Philippines 2600
Tel. Nos.: (+6374) 442-3316, 442-8220; 444-2786;
442-2564; 442-8219; 442-8256; Fax No.: 442-6268 Grade Level/Section: Grade 12- ABM
Email: email@uc-bcf.edu.ph; Website: www.uc-bcf.edu.ph

MODULE 6 – FINANCE Subject Teacher: Kenny Jones A. Amlos

Sample problem no. 3:

Mhina Corporation is planning to issue 100,000 shares of 10%, ₱50 par value preferred stocks for ₱80 per
share. The company pays income tax rate of 30%. Determine the cost of capital.
Solution:
₱𝟓𝟎 𝒙 . 𝟏𝟎
𝑲𝑷 =
(₱𝟖𝟎 − ₱𝟎)
= .0625 or 6.25%

Total Par value = ₱100,000 x ₱50 = ₱5,000,000

𝐓𝐨𝐭𝐚𝐥 𝐃𝐢𝐯𝐢𝐝𝐞𝐧𝐝 (₱𝟓,𝟎𝟎𝟎,𝟎𝟎𝟎 𝐱 .𝟏𝟎)
Dividend per share (DPS) = = = ₱5
𝐎𝐮𝐭𝐬𝐭𝐚𝐧𝐝𝐢𝐧𝐠 𝐒𝐡𝐚𝐫𝐞𝐬 𝟏𝟎𝟎,𝟎𝟎𝟎 𝐒𝐡𝐚𝐫𝐞𝐬

Sample problem no. 4:

Mit Pay Corporation issued preferred stocks for ₱120 per share. The issue price is ₱20 more than the
stock’s par value. The company incurred underwriting fees of ₱10 per share. The stocks will earn annual
dividends of ₱12 per share. If the tax rate is 30%, determine the cost of capital.
Solution:
₱𝟏𝟐
𝑲𝑷 =
(₱𝟏𝟐𝟎 − ₱𝟏𝟎)
= .1091 or 10.91%

Cost of ordinary shares and Retained Earnings:

The cost of using internally generated fund (retained earnings) as the source of financing is the same
as the cost of ordinary shares.
a) Stock Price Based (when dividend growth rate is available) =
𝑫
𝑲𝑶 = + 𝒈
𝑷
Where:
KO = Cost of ordinary shares
D = Expected cash dividend per share
P = Market value per ordinary share
g = Dividend growth rate (ROE x 1-Pay-out Ratio)
Least Squares Method: Y=a+bx:

∑𝑦 ∑𝑥𝑦
𝑎= 𝑏=
𝑁 ∑𝑥 2

b) Book Value Based (when dividend growth rate is not available) =

𝑷𝑬
𝑹𝑬 =
𝑷𝑪
Where:
KO = Cost of ordinary shares
PE = Projected earnings per share
PC = Current per ordinary share

Weighted Average Cost of Capital (WACC):

If a firm use both debt and equity financing, the cost of capital must include the cost of each, weighted
to proportion of each (debt and equity) in the firm’s capital structure. This is called the Weighted
Average Cost of Capital (WACC) represented by ka.

WACC (ka) = wiki + wPkP + wOkO

Where:
wi = percent (%) of debt
ki = cost of debt
wP = percent (%) of preference shares
kP = cost of preference shares

Business Finance Page 3 of 4

 Business Finance
Governor Pack Road, Baguio City, Philippines 2600
Tel. Nos.: (+6374) 442-3316, 442-8220; 444-2786;
442-2564; 442-8219; 442-8256; Fax No.: 442-6268 Grade Level/Section: Grade 12- ABM
Email: email@uc-bcf.edu.ph; Website: www.uc-bcf.edu.ph

MODULE 6 – FINANCE Subject Teacher: Kenny Jones A. Amlos

wO = percent (%) of ordinary shares

kO = cost of ordinary shares

Sample problem no. 5 (Comprehensive):

1. Goody Corporation has a capital structure as follows:
Bonds, 10 yrs., 10% ₱1,000,000
Preference shares, 10%, ₱200 par value, 10,000 shares issued &
outstanding ₱2,000,000
Ordinary shares, ₱50 par value, 30,000 shares issued & outstanding ₱1,500,000
Retained Earnings ₱ 500,000
The company’s earnings per common share (EPS) is ₱12. The common share’s current market price
is ₱60, while that of preferred stock is ₱250. The income tax rate is 30%.
Determine the following:
a. KO
b. Ki
c. KP
d. WACC

Solution:
₱𝟏𝟐
𝑲𝑶 𝒊𝒔 𝒄𝒐𝒑𝒖𝒕𝒆𝒅 𝒖𝒔𝒊𝒏𝒈 𝑩𝒐𝒐𝒌 𝑽𝒂𝒍𝒖𝒆 𝑩𝒂𝒔𝒆𝒅 𝒇𝒐𝒓𝒎𝒖𝒍𝒂, 𝒉𝒆𝒏𝒄𝒆 𝑹𝑬 =
₱𝟔𝟎
= .20 or 20%

𝑲𝒊 = . 𝟏𝟎 (𝟏−. 𝟑𝟎)
= .07 or 7%

(₱𝟐𝟎𝟎 𝒙 . 𝟏𝟎)
𝑲𝑷 =
(₱𝟐𝟓𝟎 − ₱𝟎)
= .08 or 8%

WACC (ka) = wiki + wPkP + wOkO

𝟏,𝟎𝟎𝟎,𝟎𝟎𝟎
wi = = .20 or 20%
𝟓,𝟎𝟎𝟎,𝟎𝟎𝟎

𝟐,𝟎𝟎𝟎,𝟎𝟎𝟎
wP = = .40 or 40%
𝟓,𝟎𝟎𝟎,𝟎𝟎𝟎

𝟏,𝟓𝟎𝟎,𝟎𝟎𝟎
wO = = .30 or 30%
𝟓,𝟎𝟎𝟎,𝟎𝟎𝟎

(ka) = (.20 x .07 ) + (.40 x .08) + (.30 x .20)

= .2940 or 29.4%
Recommendation: Gooddy Corporation must have a Return on Investment higher than 29.4%
to recover the cost of capital.

References:
✓ BAL 658.15 C1128, 2017. Cabrera, Ma. Elenita Balatbat and Cabrera, Gilbert Anthony B.,
Business Finance for Senior High School, GIC Enterprises
✓ BAL 658.15 G4476, 2017. Gitman, Lawrence J., et. al. Business Finance. JO-ES Publishing House,
Inc.
✓ BAL 332.4 L161, 2015. Laman, Rose Marie B. et. al. Financial System, Market & Management.
GIC Enterprises
✓ BAL 658.15 An15, 2010. Anastacio, Ma. Flordeliza, Dacanay, Roberto C. Fundamentals of
Financial Management, Rex Book Store

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