Chapter 11 - Sources Of Finance - Equity

Question 1

What are the methods of issuing shares for a quoted company

Answer 1

1. Public issue - advertise new shares for issue and anyone can buy shares (offer to subscription). There is a fixed price
2. Public offer for sale by tender - alternative to public issue. Don’t fix a price but instead state how much you are prepared to pay for let’s say 100,000 shares of something. The company would then collect all the offers and would find a price where all the shares were sold.
3. Placing - new shares being offered but where a merchant bank gets involved and their clients buys the share. 25% must be available to the public though
4. Rights issue - much more common in practice, rather than have to expense an advertisement for the ones above, a rights issues is offer of new shares to existing share holders. They all get a letter to ask if they want to buy new shares, they don’t have to buy. It has to be offered fairly, always like a 1 for 4 rights issue for example

Question 2

What are the methods of issuing shares for a unquoted company

Answer 2

They have two choices

1. Remain unquoted - in this case the only option is rights issue as they are too small to find new shareholders so must reach out to existing
2. Become quoted - it is difficult as to become quoted they must be big and have considerable shareholders but is hard if small. So how do I become a big company ? Well there are two stock exchange, the main stock exchange for big companies, however to help small become big there is the Alternative Investment Market (Aim) but the rev limits are much smaller.

Question 3

What is the purchase of a rights issue

Answer 3

Shares are offered at relatively low price and the effect of the issue is to reduce the market value of all the shares

Question 4

Rights issue - how to answer “what is the theoretical ex rights value per share ?”

Answer 4

If current price is £5 and company makes rights issue for 1 for 4 @ £3

Well it would be:

4 x £5 = £20
1 x £3 = £3

Therefore £23 / 5 = £ 4.60 per share

So though you have lost £1.60 from before (4 x 40p) you have gained £1.60 by buying at £3 but worth £4.60 so no better or worse off

Question 5

Can you sell rights issue letter

Answer 5

Yes because it theory if a company uses the rights issue equity generated it would increase the share prices. However what would a person charge for the rights letter ?

Imagine share price before rights issue is £5 and a 1 for 4 issue at £3 therefore the new price is £4.60

So if the new price is £4.60 and they only have to pay £3 the price it is issued at therefore the value of the rights is £1.60

Question 6

What is a bonus issue ? (Scrip issue)

Answer 6

Not a source of finance as it’s an issue of free shares to existing share holders. E.g 1 for 1 bonus issue

Reason companies do this is when the share price gets very high, people don’t tend to buy shares when too high so people don’t buy or sell as much. Shareholders like to be able to easily sell their shares

Question 7

What is stock split ?

Answer 7

Similar to bonus issue in that it’s not a source of finance but shares are split in value. E.g if a shareholder has 100 shares in issue they can withdraw the shares and replace them with 200 shares at half price. End up with more shares but at same overall value

Question 8

What is a scrip dividend ?

Answer 8

Is where share holders are offered shares instead of a cash dividend. So rather than taking the cash dividend you can take shares of same value, it’s up to the shareholder.

Companies love it as it’s a source of finance

Question 9

What is the most important source for any company ?

Answer 9

Internally generated - retained earning!

Profits earned by the company belong to shareholders. If my company wall has profits of 10,000 a company can pay out the full amount or only pay out 2,000 and keep 8,000 to reinvest and expand the company

Question 10

Things to consider when paying out a dividend

Answer 10

1. Clientele effect - different people want different things, old person want high dividend as a source of income isn’t interested in the company keeping retained earnings and growing as will be dead in 20 years whereas a young person wants a company to keep more for retained earnings and if company changes policy on dividend the current clientele will be upset
2. Signalling effect - if a company has always paid £2 per share but this year they don’t pay out a dividend because they want to retain the money to buy new machine, they want to grow. It might not be the case but shareholders are going to think there are problems and the company is going under when in fact it may be the opposite