chapter 3

Question 1

why do stakeholders play an important part in the operations of a business

Answer 1

they affect the direction of it
- internal drive the business decisions that move a company forward
- external will impact those business decisions to a certain degree dependent on the type of stakeholders

Question 2

what stakeholders are unique to public companies?

Answer 2

public shareholders + market analysts

Question 3

define public shareholders + their characteristics

Answer 3

entities that have an ownership stake in the business results from the purchase of company shares through the public market - they may own a extremely small fraction or a substantial piece of the business

Question 4

define market analysts + their characteristics

Answer 4

individuals who work for financial firms that make predictions about future public company performance -

Question 5

how do the predictions of market anlaysts affect the business?

Answer 5

predictions are publicly available and often indirectly affect the market value of the companies they make predictions about

Question 6

why do public markets exist?

Answer 6

the public market exists to facilitate a mutually beneficial exchange between a company that wants or needs access to capital with an individual that has capital available and wants to earn a return on that capital

Question 7

how do investors expect to porfit from buying shares of a public comany?

Answer 7

1. share price appreciation - investors hope that the prices of share in the capital markets increases over time - at which point they can sell them for a profit
2. dividends - investors will invest with the expectation that the company will return profits to the shareholders through consistent payment of dividends

Question 8

how is a company’s value determined?

Answer 8

determined by the present value fo a company’s future cash flows

Question 9

how is the market value of a company’s shares subject to change?

Answer 9

predictions of the company’s share price - if positive, they rise, if negative they will fall

predictions from market analysts and actual result may affect it as well - if they outperform the expectations, share prices rise, if they don’t, share price falls

Question 10

what’s the book value of a company’s shares

Answer 10

the company’s net asset value on a per-share basis

Question 11

are the market value and book value fo a company’s shares different?

Answer 11

yes,

Question 12

define stock dividends

Answer 12

the investor can receive additional shares of teh company

Question 13

what happens if a company stops issuing dividends

Answer 13

perceived very unfavourably by the public markets

Question 14

what happens when a private corporation is started

Answer 14

the owners first inject capital (cash) into the company in exchange for shares

Question 15

define an intial public offering

Answer 15

represents the first time a company’s newly issued shares are sold in the public markets

Question 16

what happens when a company decides to go public

Answer 16

a number of parties are involved (investment banks, lawyers, auditors, and securities exchange experts + regulators) - investment banks play a critical role in pre-marketing the IPO to large accredited private investors and institutional investors. IB ultimately influence the demand + initial price of the share at the time of the IPO

lawyers help facilitate the transactions, auditors + securities exchange professional ensure all the accounting records + paperwork are appropriate based on the requirements

the initial offering is almost exclusively sold to those large private + institutional investors in large quantities - exception: the investment brokers is one of those institutional investors and decides to sell their allotment of share to the public

Question 17

what type of market do the public engage in when they purchase shares?

Answer 17

the secondary market (usually)

Question 17

who determines the price of the shares when there’s an IPO share issuance

Answer 17

the price is determined by the primary market

Question 18

once all the IPO shares are sold, does the common share balance on the B/S change?

Answer 18

no, unless additional shares are subsequently sold in the markets (seasoned equity offering or follow-on public offering_ or the company repurchases previously issued shares

Question 18

define preferred shares

Answer 18

represents a degree of ownership that typically does not have voting rights - they are often guaranteed consistent dividend payments for an indefinite period of time

if the company is force to liquidate, the preferred shareholders are entitled to the assets of the company ahead of the common shareholders

Question 19

what type of shares are sold in an IPO?

Answer 19

common shares

Question 20

define culmulative preferred shares

Answer 20

a class of preferred shares that represents shares with special dividend rights - holders of this type of share are entitled to receive all dividends in arrears (dividends that weren’t pai in prior period) and the current year’s dividends, ahead of any dividends being paid to the common shareholders

Question 21

define non-cumulative preferred shares

Answer 21

another class of preferred shares that don’t have the special dividend right to receive dividends in arrears

Question 22

why do owners of companies create and issue different classes of shares

Answer 22

they want voting power to remain with a particular group - by issuing multiple shares they can structure the voting rights in a way that ensures other parties don’t accumulate too much voting power (or even potentially take over a company)

Question 23

define dividend

Answer 23

the distribution of a company’s earnings to its shareholders - often distributed quarterly (maybe annually) and may be paid out as cash or by issuing additional shares to the company’s shareholders

Question 24

what should a company consider when they don’t have sufficient cash but wants to continue paying dividends

Answer 24

consider stock dividends instead of cash dividends

Question 25

what 3 dates should be considered when a company wants to pay a cash dividend to its shareholders

Answer 25

1. declaration date - BoD approve + declare a dividend - on this date, the dividend becomes a legal obligation and must be recorded as a liability on the balance sheet as “dividends payable” DR. Retained earnings CR. Dividends payable
   to record dividend declaration
2. record date -when the corporation prepares a list of all the current shareholders - dividends are only paid to shareholders who own shares on the declaration date - no J/E is required
3. payment date - the company recognizes the payment of the dividend to the shareholders
   DR. dividends payable
   Cr. cash
   to record payment of dividend

Question 26

how are dividends on preferred share typically communicated?

Answer 26

as an annual dollar figure per share or annual dividend percentage

Question 27

define a dividend yield (dividend percentage)

Answer 27

a financial ratio that shows how much a company pays out in dividends each year as a percentage of its stock price

Question 28

define dividends in arrears

Answer 28

missed dividend payments - will be paid to preferred shareholders the next time a dividend is declared

Question 29

how is the dividend allocated to preferred and common shareholders

Answer 29

1. calculate the dividends to be paid to preferred shareholders (including any preferred dividends in arrears, if applicable)
2. assign the remaining dividend to common shareholders

Question 30

After an IPO, if the company needs more capital is a seasoned equity offering the only or best option?

Answer 30

it depends on debt or equity financing results for the company

Question 31

what are the pros + cons of debt financing

Answer 31

pros:
- no dilution of ownership
- once debt is paid off, no further commitment to lender required
- tax savings, as interest is an expense that reduces taxable income

cons:
- requires continuous repayment (principal + interest)
- rising interest rates can increase cost of borrowing
- assets can be seized if business cannot pay back the loan
- company might need to meet certain bank covenants

Question 32

what are the pros + cons of equity financing

Answer 32

pros:
- no legal requirement of continuous repayment
- less restrictive on the use of funds

cons:
- dilution of ownership/control
- high pressure to achieve results as shareholders expect continuous share appreciation/dividend payments
- difficult + costly to raise equity
- will require new governance, reporting, processes, regulatory requirements, etc

Question 33

what’s the company’s weighted average cost of capital?

Answer 33

represents the cost to acquire additional financing and fluctuates depending on the level of debt vs equity a company holds - it’s expresssed as a percentage

• companies tru to minimize their WACC and have to calculate the impact of additional debt or equity on their WACC.

Question 34

what’s the difference between issuing bonds vs stocks?

Answer 34

bonds represent a promise to repay with interest rather than ownership in the company

Question 35

which is bigger? global bond market vs global stock market

Answer 35

bond market