6. Financing Capital Projects Flashcards
What are ordinary shares?
The owners of the business who have voting rights but are only paid dividends and the discretion of the directions
What are preference shares?
Usually a fixed dividend with limited or no voting rights
In the event of liquidation, which rank first: ordinary shares or preference shares?
Preference shares
Can preference shares be secured against a company’s assets?
No
What are participating preference shares?
Preference shares that carry the right to fixed dividends plus an additional dividends when ordinary dividends exceed a certain level
What are convertible preference shares?
Shares that can be converted into ordinary shares after a specified time, if the market value of the ordinary shares exceeds the preference share value
What are bonds?
A negotiable instrument offering a fixed interest rate over a period of time and with a fixed redemption value
What are two other terms for bonds?
Loan stock or debentures
What is convertible date?
Debt that can either be redeemed or converted to a predetermined number of shares at a future date
What is venture capital?
VC firms provide equity instruments to potential growth businesses
What are grants?
Non repayed government funding for particular purposes
What is an equity warrant?
A security issued by a company giving the holder the right be allocated ordinary shares in the company on terms specified in the warrant
What is traded on the capital markets?
Debt (bonds) or equity (shares) > 12 months
What are the 5 functions of the stock market?
- Enable companies to raise new finance
- Enable existing investors to buy/sell
- Aid takeovers
- Enable private companies to realise their investment by floating the company
- Enable companies to offer shares in incentive schemes
What are the 4 methods of issuing share capital?
- Rights Issue
- Public Offer - Offer for Sale
- Public Offer - Public Issue
- Placing
What is a rights issue of shares?
An invitation to existing shareholders to purchase additional shares
What is an offer for sale?
Shares offered via issuing house (underwritten) to the public at a fixed price
What does it mean if a share offer is underwritten?
The underwriter guarantees to buy any unbought shares
What is a public issue?
Shares offered directly to the public that are not underwritten
What is share placing?
Issuing shares to a select group of institutional investors
What are fixed charges?
Security on debt through charges on specific assets the company holds
What are floating charges?
Security on debt through charges on underlying assets of the company that are subject to changes e.g. inventory
What are covenants?
The actions of the borrower are restricted e.g. restricted dividends or minimum liquidity ratios
What are the 4 types of bond?
- Irredeemable
- Redeemable
- Convertible
- Warrant attached
Who requires a higher return on investment - equity investors or debt issuers?
Equity investors
What is higher, the cost of debt or the cost of equity?
Cost of equity
What is the equation for cost of capital for shares with zero growth dividends?
Dividend / Ex-dividend share price
What is the equation for cost of capital for shares with dividends with constant growth?
(Dividend in 1 year / Ex-dividend share price) + growth %
OR
(Dividend just paid*(1 + growth %))/Ex-divident share price) + growth %
What is Gordon’s model for estimating growth rate of dividends?
g = r x b r = ROCE b = proportion of funds reinvested in the business
What is the formula used to estimate dividend growth using historic growth?
g = nth root (latest dividend/historic dividend) - 1
What is the equation for cost of capital for preference shares?
Dividend / Ex-dividend share price
**Pref gives constant dividend so we use the zero growth equation
Why is debt cheaper to the business than equity? (2)
- Lower risk so lower returns required
2. Tax relief on interest but not on dividends
What is the equation for cost of irredeemable debt?
( interest * (1 - tax rate) ) / current ex-interest price
How do we calculate the cost of redeemable debt?
Find the cost of capital that equates the inflows to the outflows
I.e. the IRR calculation for (Ex int market value) + discounted interest payments net of tax + discounted redemption amount = 0
What is the yield to maturity calculation for irredeemable debt (from the investor’s perspective)?
Annual interest / Ex-interest market value of debt
How do we calculate the yield to maturity of redeemable debt?
The same as the cost to the investee (IRR) but not removing tax
For convertible debt, how do we calculate the cost of convertible debt?
The IRR calculation, with the redemption amount set as the higher of the redemption value and the value of the ordinary shares
What is the cost of a bank loan?
Interest rate x (1 - tax)
What is the formula for weighted average cost of capital?
cost of equity x (Market val of shares / total market value of debt and equity)
+
cost of debt net of tax x (Market val of debt/ total market value of debt and equity)
Do we want projects with returns higher or lower than our WACC?
Higher
