Chapter 3

Question 1

what are some universal internal and external stakeholders

Answer 1

Internal stakeholders:
- executives
- management team
- BOD
- private investors
- employees

external stakeholders:
- lending institutions
- governments
- regulatory bodies
- vendors / suppliers
- competitors

Question 2

what are some stakeholders that are unique to public companies?

Answer 2

Public shareholders – these are entities (i.e., people or corporations) that have an ownership stake in the business resulting from the purchase of company shares through the public markets. They may own an extremely small fraction of the business (e.g., 0.00001%) or a substantial piece (e.g., 25%), however they are considered owners, nonetheless. We will continue to learn about public shareholders throughout this chapter.

Market analysts – market analysts generally comprise individuals who work for financial firms that make predictions about future public company performance. These predictions are publicly available and often indirectly affect the market value of the companies they make predictions about. You’ll learn how this takes place later in the chapter.

Question 3

what are some types and classes of shares?

Answer 3

Preferred shares are the other main type of stock (alongside common shares) that represents a degree of ownership in a company but typically does not have voting rights. However, they often guarantee consistent dividend payments for an indefinite period of time. Additionally, if the company is forced to liquidate, preferred shareholders are entitled to the assets of the company ahead of the common shareholders.

Cumulative preferred shares are 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 (i.e., dividends that were not paid in prior periods) plus the current year’s dividends, ahead of any dividends being paid to the common shareholders.

Non-cumulative preferred shares are another class of preferred shares that do not have the special dividend right to receive dividends in arrears.

Common shares (can have multiple classes): have voting rights but are not guaranteed a dividend

Question 4

what is a dividend

Answer 4

is the distribution of a company’s earnings to its shareholders.

Question 5

what is the formula for ending retained earnings

Answer 5

ERE = Beginning RE + net income - dividends declared

Question 6

what is the 3 dates associated with declaring dividends

Answer 6

1. declaration date
2. record date
3. payment date

Question 7

what is the declaration date?

Answer 7

the Board of Directors approve and 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

Question 8

what is the record date

Answer 8

this is 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 journal entry is required.

Question 9

what is the payment date

Answer 9

the company recognizes the payment of the dividend to the shareholders:

DR. dividends payable
CR. cash

Question 10

what is a dividend yield?

Answer 10

If a company uses a dividend percentage, this is called a dividend yield, which is a financial ratio that shows how much a company pays out in dividends each year as a percentage of its stock price.

Question 11

what are dividends in arrears

Answer 11

if a company has cumulative preferred shares outstanding and it misses a dividend payment, these missed dividend payments are called dividends in arrears and will need to be paid to preferred shareholders the next time a dividend is declared.

Question 12

what are the pros of issuing debt

Answer 12

• 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

Question 13

what are the cons of issuing debt

Answer 13

• Requires continuous repayment (principal and 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 14

what are the pros of issuing equity

Answer 14

• No legal requirement of continuous repayment
• Less restrictive on the use of funds

Question 15

what are the cons of issuing equity

Answer 15

• Dilution of ownership / control
• High pressure to achieve results as shareholders expect continuous share appreciation/dividend payments
• Difficult and costly to raise equity
• Will require new governance, reporting, processes, regulatory requirements, etc.

Question 16

what is a company’s weighted-average cost of capital

Answer 16

represents the cost to acquire additional financing and fluctuates depending on the level of debt vs. equity a company holds. It is expressed as a percentage.