Engineering Economy Module 7

Module 7
CAPITAL FINANCING
Engr. Gerard Ang

School of EECE
Equity and Borrowed Capital
Types of Business Ownership
 Individual Ownership or Sole Proprietorship – is one
which is owned and run by one individual and where there is
no legal distinction between the owner and the business.
 Partnership – is an association of two or more persons for

the purpose of engaging in business for a profit.
 Corporation – is a fictitious being, recognized by law, that

can engage in almost any type of business transaction in
which a real person could occupy himself. It operates under
a charter that is granted by the government.
Advantages and Disadvantages
of Sole Proprietorship
Advantages:
 It is easy to organize.
 The owner has full control of the enterprise.
 The owner is entitled to whatever benefits and profits that accrue from
the business.
 It is easy to dissolve.
Disadvantages:
 The amount of equity capital which can be accumulated is limited.
 The organization ceases upon the death of the owner.
 It is difficult to obtain borrowed capital owing to the uncertainty of the
life of the organization.
 The liability of the owner for his debts are unlimited.
of Partnership
Advantages:
 More capital may be obtained by the partners pooling their resources together.
 It is bound by few legal requirements as to its accounts, procedures, tax forms
and other items.
 Dissolution of a partnership may take place at any time by mere agreement of
the partners.
 It provides an easy method whereby two or more persons may enter into
business each carrying those burdens that he can best handle.
Disadvantages:
 The amount of capital that can be accumulated is definitely limited.
 The life of the partnership is determined by the life of the individual partners.
When any partner dies, the partnership automatically ends.
 There may be serious disagreement among individual partners.
 Each partner is liable for debts of the other partnership.
of Corporation
Advantages:
 It enjoys perpetual life without regard to any change in the person of its
owners, the stockholders.
 The stockholders of the corporation are not liable for the debts of the
corporation.
 It is relatively easier to obtain large amounts of money for expansion due
to its perpetual life.
 The ownership in the corporation is readily transferred.
 Authority is easily delegated by the hiring of the managers.
Disadvantages:
 The activities of the corporation are limited to those stated in its charter.
 It is relatively complicated in formation and administration.
 There is greater degree of government control as compared to other types
of business organization.
Capitalization of a Corporation
The capital of a corporation is acquired through the sale of stock. There
are two principal types of stock.
 Common Stock – represents ordinary ownership without special

guarantees of return.
 Preferred Stock – are guaranteed a definite dividend on their

stocks. In the case the corporation is dissolved, the assets must be
used to satisfy the claims of the preferred stockholders before
those of the common stockholders. Preferred stockholders usually
have the right to vote in meetings, but not always.
Rights of Common Stockholders
Financing of Bonds
 Bond – is a certificate of
indebtedness of a corporation
usually for a period of not less
than 10 years and guaranteed
by mortgage on certain assets
of the corporation or its
subsidiaries. Bonds are
issued when there is a need
for more capital such as for
expansion of the plant or the
services rendered by the
corporation.
 Face or Par Value of a Bond – is the amount stated on the bond.

When the face value has been repaid, the bond is said to have been
retired or redeemed. The bond rate is the interest rate quoted in the
bond.
Classification of Bonds
According to the Method of Paying Interest:
 Registered Bond – the name of

the owner of this bond is recorded
on the record books of the
corporation and interest payments
are sent to the owner periodically
without any action.
 Coupon Bond – have coupon

attached to the bond for each
interest payment that will come due
during the life of the bond. The
owner of the bond can collect the
interest due by surrendering the
coupon to the offices of he
corporation or at specified banks.
Classification of Bonds
According to the Security Behind the Bonds:
 Mortgage Bond – this is one of the most
common type of bonds. The security behind
these bonds is mortgage upon certain specified
assets of the corporation in the form of a trust
deed. If the corporation fails to pay the value of
the bond at the date of maturity, title to the
property is transferred to the stockholders.
 Collateral Bond – the security behind this type

of bond is the stocks or bonds of a well-
established subsidiary of the corporation.
 Debenture Bond – a bond without any security

behind it except a promise to pay the issuing
corporation.
Methods of Bond Retirement
 The corporation may issue another set of bonds
equal to the amount of bonds due for redemption.
 The corporation may set up a sinking fund into which
periodic deposits of equal amount are made. The
accumulated amount in the sinking fund is equal to
the amount needed to retire the bond at the time they
are due.
 The corporation may issue callable bonds. These
bonds permit repayment of the principal before
maturity.
Value of a Bond
The value of a bond is the present worth of all future
amounts that are expected to be received through
ownership of the bond.
−𝐧 −𝐧
𝟏 −(𝟏+𝐢)
−𝐧
𝐕 𝐧𝐧 =𝐂 (𝟏+𝐢)−𝐧 +𝐅𝐫 [
𝐢 ]
Where:
F = face or par value
C = redemption or disposal price (often equal to F)
r = bond rate per period
n = number of interest period
i = interest rate or yield per period
P = value of the bond in periods before redemption
Sample Problems on Bonds
1. A 10 year corporate bond has a face value of
Php5,000 and a bond rate of 8% payable quarterly. A
prospective buyer desires to earn a nominal rate of 12%
quarterly on investment. What purchase price would
the buyer be willing to pay? (php 4,573.49)
2. A bond with a par value of Php1,000 and with a bond

rate of 16% payable annually is sold now for
Php1,050. If the yield is to be 14%, how much should
be the redemption price at the end of seven
years?
(Php 910.50)
Sample Problems on Bonds
3. A bond issue of Php200,000 in 10 year bonds, Php1,000 units,
paying 16% nominal interest in semiannual payments, must be retired
by the use of a sinking fund that earns 12% compounded
semiannually. What is the total semiannual expense?
4. A man wants to make a 14% nominal interest compounded

semiannually on a bond investment. How much should the man be
willing to pay now for a 12% compounded semi-annually,
Php10,000 bond that will mature in 10 years and pays interest
semiannually? (Php 8,909.89)
5. A Php1,000 bond which will mature in 10 years and with a bond

rate of 8% payable annually is to be redeemed at par at the end of
this period. If it is sold at Php1,030, determine the yield at this price.
(7.56%)

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Module 7

Engr. Gerard Ang

 Partnership – is an association of two or more persons for

 Corporation – is a fictitious being, recognized by law, that

 Common Stock – represents ordinary ownership without special

 Preferred Stock – are guaranteed a definite dividend on their

 Face or Par Value of a Bond – is the amount stated on the bond.

 Registered Bond – the name of

 Coupon Bond – have coupon

 Collateral Bond – the security behind this type

 Debenture Bond – a bond without any security

2. A bond with a par value of Php1,000 and with a bond

4. A man wants to make a 14% nominal interest compounded

5. A Php1,000 bond which will mature in 10 years and with a bond

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