National and international financial system offers companies a wide range of funding sources. The choice of one or more of the available sources and their combination are major aspects of the company's financing policy. Managers must keep in mind that the call to one or other of potential funding sources is not a minor and independent decision, but has profound implications on the company’s value. Weighted average cost of capital can be used as the discount rate or the selection of investment projects.financing policy, cost of capital, capital structure, company’s value

Botoc Claudiu

Nicolescu Cristina

Pirtea Marilen

English

Research Papers in Economics

388 
 
THE IMPACT OF FINANCING POLICY ON THE COMPANY’S VALUE 
Pirtea Marilen 
West University of Timi oara, Faculty of Economics and Business Administration 
Bo oc Claudiu 
West University of Timi oara, Faculty of Economics and Business Administration 
Nicolescu Cristina 
West University of Timi oara, Faculty of Economics and Business Administration 
 
National and international financial system offers companies a wide range of funding sources. 
The choice of one or more of the available sources and their combination are major aspects of 
the company's financing policy. Managers must keep in mind that the call to one or other of 
potential funding sources is not a minor and independent decision, but has profound implications 
on the  company’s value. Weighted average cost of capital can be used as the discount rate or the 
selection of investment projects. 
 
Keywords: financing policy, cost of capital, capital structure, company’s value. 
 
JEL code: G32 
 
1. Introduction 
Financing  policy  at  microeconomic  level  is  significantly  influenced  by  how  the  economic 
mechanisms  function  at  regional,  national  and  even  global.  Romania  is  characterized  by  a 
relatively unstable socio-economic situation and, which raises serious toll on the business results 
of  Romanian  companies,  irrespective  of  quality  management  at  the  microeconomic  level. 
Considering the specifics of economic and financial environment in the context of analysis of the 
influence these areas have on the the finance decision at microeconomic level, one cannot ignore 
elements such as inflation, changes in interest rates or exchange rate in economy
341. 
Although  these  macroeconomic  factors  are  especially  useful  for  the  substantiation  of  policy 
finance companies, there are other factors that influence financing policy, factors related to the 
company's  internal  environment.  Taking  into  account  these  observations,  and  various  other 
related to financing policies, we may wonder why some  sectors of the activity tend to have 
companies with a high rate of borrowing compared to other sectors. But analyzing the role of the 
financial lever, the cost sources of funding or fees paid by the company, we can explain these 
changes in borrowing rates, and how the company's value is affected by the financing policy.
 342 
Among  these  factors,  we  consider  the  cost  of  financing  sources  as  the  primary  factor  in 
foundation financing policy, having the greatest impact on company results and hence on its 
value. 
Financing policy, which underpins the company's capital formation, is mostly assumed by the 
company's management and less by the "providers" of capital (shareholders, creditors). This can 
be achieved in two ways: internal financing and external financing. But each of these sources 
implies a specific cost to achieve them, cost which the manager should know, considering also 
the indirect implications of choosing one or other of these financing arrangements. 
                                                       
341  Oprean  Camelia,  An  analyses  of  Romanian  companies  financing  decision  under  macroeconomic 
influences, MPRA Paper No 14716, 2008. 
342  Fabozzi  F.,  Drake  Pamela,  Finance.  Capital  Markets,  Financial  Management  and  Investment 
Management, John Wiley & Sons, Inc, New Jersey, 2009. 389 
 
 
2. The cost of financing sources – esential factor of company policy 
Due to its crucial role in all production factors, capital has a privileged position in all theoretical 
approaches aimed by business activity
343. So, we can appreciate the capital as all funding sources 
available to the company that can be used to purchase all the elements of the asset
344. Considering 
the source of the company`s capital is composed primarily of two components: equity and debt. 
 
2.3.1 The cost of equity – determination methods 
Equity cost represents the rate of return required by shareholders is the company to pay for their 
investment in the company. If the rate of return is lower than the opportunity cost, then the 
business value decreases,  and if the rate of return is higher than the opportunity cost,  then the 
business value increases. The rate of return expected by shareholders is an opportunity cost based 
on expected return of investors to invest the same risk. In the absence of resale transactions of 
existing shares, shareholders will earn dividends only. If the future flow of dividends is known, 
the discount rate that equales the present value of dividends by the current price action will be the 
required rate of return for investors. The difficulty of the model lies in determining the exact level 
of future dividends. Therefore, research in the field  tried to find ways of estimating this rate of 
return expected by investors, which the most significant are presented in the following table: 
 
Table 1 
Methods for determining the cost of equity 
Crt. 
Nr. 
 
Method  Formula 
1  Gordon-Shapiro 
Model  g
V
D
ke + =
0
1                                              (1) 
: 
0
1
V
D
= the dividend yield per share 
g = the growth rate of dividend per share. 
2  Model of 
determining by PER 
(market 
capitalization ratio) 
e k Rrf
PER
1 1
= =  (4)         g
EPS V
g d
k
t t
e +
+ *
=
/
) 1 (
  (5) 
:  d – dividend rate 
EPSt – earnings per share at time t 
Vt/EPSt = PERt 
3  Capital Asset Pricing 
Model (CAPM)  ] ) ( [ Rf R E Rf ke - * + = b                     (6) 
: Rf –risk-free interest rate 
β – Title volatility, systematic risk expression relative to market portfolio 
( ) R E  – expected return on market portfolio 
4   Arbitrage Pricing 
Theory Model (APT)  å
=
* + =
K
k
ik ik e b Rf k
1
l                                   (7) 
: bik – sensitivity coefficient of the company at the risk factor k 
å
=
=
T
t
kt k
1
l l - average risk premium in the period under review 
                                                       
343 Nistor I., Teorie  i practică în finan area întreprinderilor, Ed. Casa Căr ii de  tiin ă, Cluj-Napoca, 
2004. 
344 Berceanu D., Deciziile financiare ale firmei, Edi ia a II-a, Ed. Universitaria, Craiova, 2006. 390 
 
T – number of periods analyzed 
t Rf 0 l = - risk-free rate at time t 
K – number of risk factors 
5  Updated cash flow 
model, for preferred 
shares  å
=
=
+
=
n
t p
t
p
t
k
Div
k
Div
V
1
0 ) 1 (
                           (8) 
: Divt – forecasted dividend to be distributed for year t 
Div1 = ...= Divn =Div = constant 
kp – cost of capital for preferred shares 
6  Rata rentabilită ii 
financiare 
Cpr
Rrf
net p
=                                                                          (10) 
: πnet – net profit 
Cpr – equity value 
Source: Processing after Pirtea M., Cristea H., Nicolescu Cristina, Bo oc C., Managementul financiar al 
companiei, Mirton Publishing House, Timi oara, 2010. 
  
2.3.2 The cost of lent capital - determination methods 
To  estimate  the  cost  of  borrowed  capital  can  be  used  two  types  of  methods: 
A. A company`s exogenous methods such as: 
-  Negotiations with potential manufacturers; 
-  Based on market interest rates on loans with similar risk issued instruments;   
-  Based  on  actual  interest  rate  subsidy  payed  by  firms  in  the  same  sector. 
B. A company`s endogenous methods: 
In  addition  to  exogenous  methods,  the  company  can  estimate  the  cost  of  debt  taking  into 
consideration the  interest rates on loans issued by the company, called yield to maturity method, 
YTM.  Yield  to  maturity  is  the  interest  rate  that  would  be  won  by  one  investor  on  similar 
instruments, which bought the title at the current price and that keeps it until maturity.
 345 The 
cost  of  borrowed  capital  will  increase  over  the  yield  to  maturity  under  the  impact  of 
administrative costs, the various fees involved with a new issue. In these circumstances, the cost 
of debt (kd), under the impact of taxation, is given by the following formula: 
                                                  ( ) p I YTM kd - * = 1                                      (11) 
 Iπ – profit tax rate 
 
One of the significant risks that are facing the creditors of companies is the risk of default by the 
company  issuing  debt  (bankruptcy  risk).  Effect  of  bankruptcy  risk  should  be  considered  in 
determining the discount rate, but also the expected value of cash-flow analysis of investment 
project  sites.  In  these  circumstances,  estimating  the  expected  profitability  by  the  creditors 
imposes  the  determination  of  the  payments`  sensitivity,  depending  on  the  macroeconomic 
indicators. Therefore, a second method for determining the cost of debt is the CAPM model, 
which involves calculating the β coefficient for debts: 
                                          ( ) [ ] t dat t t dat Rf R E Rf k - * + = b ,                                          (12) 
unde:   Rft – rate of return on a risk-free bond at time t 
  ( ) t Rf R E -  - risk premium for the market portfolio at time t 
                                                       
345 Stancu I., Finan e, edi ia a IV-a, Ed. Economică, Bucure ti, 2007. 391 
 
 
Using this formula, however, leads to determining the expected value of return to creditors, that 
is usually different from the actual value. The report of  the two values is determined by the risk 
of non-payment of obligations to creditors and the likelihood of bankruptcy. In case of the two 
events,  then  the  actual  amount  will  be  less  than  expected  value,  otherwise  being  above  the 
expected value. 
 
 
 
2.3.3 The weighted average cost of capital -influence on the company's financing policy 
Choosing a means of funding is determined on the one hand by its cost and secondly by the 
company's current financial structure.
 346 Optimal financial structure corresponds to the minimum 
cost of used capital, weighted average cost (WAC) being determined using the following relation: 
                                                        å
=
* =
t
1 i
i i k w WAC                                                     (13) 
unde:  wi –shared capital, by the sources of origin 
  ki  -the cost of the i source of financing 
  t – the number of financing sources 
The principle underlying the determination of weighted average cost of capital calculation takes 
into  account  the  WAC  in  accordance  with  how  the  cash-flows  that  have  to  be  updated  are 
denominated. For this, the following elements should be considered: 
1. The taxation of cash-flows. If these are taxed, then the CPM will be determined after taxation 
its parts: 
           
capital   Total
Equity
k
capital   Total
Debts
) I (1 k WAC e π debts * + * - * =                     (14) 
   
2. Using nominal rates, if cash-flows are expressed in nominal sizes. 
WAC can be used as discount rate in assessing cash-flows of a company`s investment projects . 
Using WAC as the discount rate is an appropriate valuation method based on updating the sites of 
future  cash  flow,  because  the  whole  value  of  the  company  has  invested  capital  (own  or 
borrowed). Thus, the economic asset value will be given by: 
                             
( ) å
=
+
+
+
+
=
n
1 t
ar n
n
t
t
0 V
WAC) (1
VR
WAC 1
CF
V                                       (15) 
unde:  CF – cash-flows of the company, on the three types of activities 
  Var – value of redundant assets 
 
WAC calculation proves its usefulness also in selecting investment projects, being the minimum 
threshold  below  which  investors  will  not  accept  to  fall,  representing  an  investment  return 
required for the company that has an identical  risk of the same company as a whole. If the new 
project has the same risk as a whole company, then WAC can be used in determining the net 
present value (NPV), as a criterion for selection of investment projects: 
                                               å
=
-
+
=
n
1 t
0 t
t I
WAC) (1
CF
NPV                                            (16) 
unde:  I0 – value of initial investment 
                                                       
346 Pirtea M., Cristea H., Nicolescu Cristina, Bo oc C., Managementul financiare al companiei, Ed. Mirton, 
Timi oara, 2010. 392 
 
  CFt – annual forecast cash-flows forecast, after tax. 
 
If the investment project has a different risk than the company`s, then the discount rate of cash 
flow may differ from the value of  the company`s WAC. In this case, the CAPM model is 
recommended for determining the discount rate, in which the right SML (Security Market Line) 
is the geometrical point of all updated rates of investments, proportionally to the risk adjusted to 
the rates of investment. 
   
3. Creating value – effect of the company`s decisions 
Intelligent investment decisions make the shareholders richer. For example, if a company can 
borrow 8%, when the interest rate is 9%, then it can be said that the company manager did a good 
deed for shareholders. 
Unfortunately,  this  is  easier  to  be  said  than  done.  The  problem  is  that  financial  markets 
competition  is  more  intense  than  in  most  product  markets.  On  product  markets,  generally, 
businesses can find competitive advantages that allow positive NPV investments. For example, a 
company may have only a few competitors who specialize in the same line of business and in the 
same geographical area. Or can be able to seize the patent, technology or on the recognition and 
customer loyalty. All these offer the opportunity to obtain higher profits and to find positive NPV 
projects
347. 
But there are few protected niche in the financial markets and you can not patent issuance of new 
securities.  In  addition,  you  are  facing  on  these  markets  always  a  fast-moving  competition, 
including  all  other  companies  seeking  capital,  not  even  considering  the  state,  the  local 
administrations, the financial institutions, the foreign and individuals companies ranging from 
New  York,  Tokyo  or  London  funding.  Investors  who  have  a  surplus  capital  are  many  and 
intelligent. Most likely, these investors assess the value of securities at least as well as issuers. 
Of course, when a company calls to loans, it wants that the borrowed resources to cost less than 
market interest rate. But if the loan is a good deal for shareholders, it must be a bad deal for 
creditors. So there is a dilemma linked to how a company is likely to deceive investors constantly 
forcing them to pay a surcharge for the securities issued. The answer is very obvious, very small, 
generally companies should assume that they issue securities which are sold at true value. 
But the real value is a slippery potential expression, the actual final value does not mean future 
value, because differences may occur between predictions and the actual recorded level (we do 
not expect investors to be observers by chance). Fair value reflects a price which includes all 
current information available to investors on an efficient capital market,  all securities being 
valued at a fair price. In such circumstances, the sale of securities at market price can never be a 
positive NPV transaction 
 
4. Conclusions 
Funding sources must be selected in accordance with the objectives to finance and economic 
environment in which it operates. Also, the company's financial strategy must always follow the 
indicators "net income per share", "gross dividend per share" or realistic "net dividend per share" 
because any investor bases his investment decisions according to actual earnings. 
For a capital investment to be justified, the profitability of invested resources must at least equal 
the same risk return investment alternatives, and we formulate the idea that the cost of capital is 
an opportunity cost. 
                                                       
347 Brealey R., Myers S., Marcus A., Fundamentals of corporate finance, 5
th Edition, McGraw Hill/Irwin 
Publishing House, New York, USA, 2007. 393 
 
If WAC analysis is performed in terms of business, then we are  talking in terms of cost that you 
must pay for dispunde sources of funding. But analysis can be performed from the perspective of 
investors who wish to obtain a certain gain from their investment in the company, and then talk in 
terms of profitability. 
All these hypotheses argues that it is hard to win or lose based on funding strategies, either smart 
or stupid. It is difficult to win, which means finding cheap sources for funding, because investors 
demand fair market conditions. At the same time, it's hard to lose, because competition among 
investors prevent any of them, in terms of requirements, rather than reasonable conditions. 
 
References: 
1.  Berceanu D., Deciziile financiare ale firmei, Edi ia a II-a, Ed. Universitaria, Craiova, 2006. 
2.  Brealey R., Myers S., Marcus A., Fundamentals of corporate finance, 5
th Edition, McGraw 
Hill/Irwin Publishing House, New York, USA, 2007. 
3.  Fabozzi F., Drake Pamela, Finance. Capital Markets, Financial Management and Investment 
Management, John Wiley & Sons, Inc, New Jersey, 2009. 
4.  Nistor I., Teorie  i practică în finan area întreprinderilor, Ed. Casa Căr ii de  tiin ă, Cluj-
Napoca, 2004. 
5.  Oprean  Camelia,  An  analyses  of  Romanian  companies  financing  decision  under 
macroeconomic influences, MPRA Paper No 14716, 2008. 
6.  Pirtea M., Cristea H., Nicolescu Cristina, Bo oc C., Managementul financiar al companiei, 
Ed. Mirton, Timi oara, 2010. 
7.  Stancu I., Finan e, edi ia a IV-a, Ed. Economică, Bucure ti, 2007. 
 
 
 
   

An analyses of Romanian companies financing decision under macroeconomic influences,

Bo oc C., Managementul financiar al companiei,

Capital Markets, Financial Management and Investment Management,

Deciziile financiare ale firmei, Edi ia a II-a,

Finan e, edi ia a IV-a,

Fundamentals of corporate finance, 5 th Edition,

Teorie i practică în finan area întreprinderilor, Ed. Casa Căr ii de tiin ă,

THE IMPACT OF FINANCING POLICY ON THE COMPANY’S VALUE

http://anale.steconomiceuoradea.ro/volume/2010/n1/060.pdf

THE IMPACT OF FINANCING POLICY ON THE COMPANY’S VALUE

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