Debt Vs Equity Instruments

Characteristics of Debt and Equity Instruments

Team D: Steven Harrison, Jessica Jefferies, Arlene Rivera, Kairstin Roberts,

FIN476

Mr. Seth Fargen

January 29, 2007

Financial Instruments

Financial Instruments are the lifeblood of any successful company; they are like rivers of living water that brings life and nourishment in order to grow into a strong company. Financial Instruments fall into two categories, debt and equity.

Debt is a financial instrument that is used to finance an organization by paying back borrowed capital with interest. Debt instruments are notes, loans, bonds, and debentures are used to pay for needs for an entity preferably in the short term. An advantage of good debt is the predictability of payments to investors. Investors can assume less risk of loss in their investment. Borrowed money that is used to obtain assets will allow a company to keep its profits. Another advantage of debt is that loans are usually tax deductible. Some disadvantages of debt are that a company must have sufficient cash flow to repay loans. Loans that are considered risky may require justification for the loan and require collateral to back up the loan should it result in default. The end result will more than likely be a much higher interest rate.

Equity or common stock is a more basic form of an equity instrument. Common stock is ownership interest in a corporation, which includes interest on earnings. Interest on earnings translates to dividends as well as interest in assets distributed upon dissolution. Holders of common stock have a great opportunity to share the entity’s profitability because of unlimited potential for dividends. Likewise, common stock holders also bear the greatest risk of loss because they are subordinate to all other creditors and preferred stockholders. The advantages of equity are that there is no obligation to pay back the amount invested. Businesses will have more cash available because of no debt payments. Another advantage of equity is that business assets do not have to be pledged as collateral to get equity investments. The biggest disadvantages of equity are that profits go to other equity investors and taxes are non deductible.

Organization Comparison

Pfizer Pharmaceuticals Inc., (NYSE: PFE) is a healthcare drug manufacturing company that was established in 1849. They are headquartered in New York, NY with products that include Lipitor, Viagra, and Zoloft. In 2005, their total revenue was $51.298 billion and had an estimated 106,000 employee’s world wide.

Pfizer is an organization that utilizes both equity and debt instruments to finance their operations. Pfizer heavily relies on operating cash flow, short-term commercial borrowing and long-term debt to provide for its working capital needs, which includes R&D activities. The company’s short-term and long-term investment comprise primarily of high-quality, liquid investment grade available for sale debt securities. Pfizer’s third quarter financial statement states that as of October 1, 2006 its total debt was $8,069 million, with its long-term debt being $5,561 million and short-term borrowings adding to $2,508 million. Short-term borrowing was dramatically reduced by $9,000 million from last year due its reductions of short-term investments. In the third quarter of 2006, par value plus accrued interest, $1 billion of senior unsecured floating-rate notes were redeemed. In February 2006, Pfizer also issued Japanese yen fixed-rate bonds to be used for general corporate purposes. This entails $508 million of senior unsecured notes that are due February 2011, which pays interest semi-annually at a rate of 1.2% and, $466 million of senior unsecured notes that are due February 2016 which also pay interest semi-annually with a rate of 1.8%.

As of October 1, 2006 Pfizer’s total shareholder’s equity was $69,712 million with common stock comprising $441 million, additional paid-in capital of $68,865 million, and its shareholder’s equity per common share came to $9.70. The first nine months of 2006, $18.8 billion was used in financing activities, which was primarily attributed to an increase in cash dividends paid of $1.0 billion and higher purchases of common stock of $4.5 billion as compared to $3.4 billion in 2005. In recent