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Sources of Long-Term Debt Financing

• Financial leverage– The use of borrowed funds to increase the return on

owners’ equity– As long as the firm’s earnings are larger than the

interest charged for the borrowed money, there is a positive effect on return on owners’ equity

• Lease– An agreement by which the right to use real estate,

equipment, or other assets is temporarily transferred from the owner to the user

– Sometimes used if a firm cannot obtain a loan to acquire property, buildings, or equipment

– Can have tax advantages over long-term debt financing

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Effects of Additional Capital

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Sources of Long-Term Debt Financing (cont’d)

• Long-term loans– Term-loan agreement

• For loans longer than 1 year

• A promissory note that requires a borrower to repay a loan in monthly, quarterly, semiannual, or annual installments

– Interest rate and repayment terms are based on the reasons for borrowing, the firm’s credit rating, the value of collateral

– Getting a loan• Know potential lenders

• Maintain a good credit rating

• Fill out an application; submit a business plan and financial statements; compile references

• Meet with loan officer

• If denied, determine why

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Sources of Long-Term Debt Financing (cont’d)

• Corporate bonds– A corporation’s written pledge that it will repay a

specified amount of money with interest– Maturity date—the date on which the corporation is to

repay the borrowed money– Interest is paid until maturity– Types of bonds

• Registered bond—a bond registered in the owner’s name by the issuing company

• Debenture bond—a bond backed only by the reputation of the issuing corporation

• Mortgage bond—a bond secured by various assets of the issuing firm

• Convertible bond—a bond that can be exchanged, at the owner’s option, for a specified number of shares of the corporation’s common stock

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Sources of Long-Term Debt Financing (cont’d)

• Corporate bonds (cont’d)– Repayment provisions for corporate bonds

• Bond indenture—a legal document that details all the conditions relating to a bond issue

• Call premium—an amount paid to the bond owner if the corporation buys back the bond before the maturity date

• Serial bonds—bonds of a single issue that mature on different dates

• Sinking fund—a sum of money to which deposits are made each year for the purpose of redeeming a bond issue

• Trustee—an individual or an independent firm that acts as the bond owners’ representative

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Comparison of Long-Term Financing Methods

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