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AFM 182 > Chapter 3: Public Markets > Flashcards

Chapter 3: Public Markets Flashcards

Explain how the public market context introduces new stakeholders that a public company must consider, Explain the process of raising capital through public markets, Differentiate between various types and classes of shares, Understand the financing options available to public companies

1
Q

what are stakeholders

A

Parties that have an interest in a company because they can affect or be affected by the business

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2
Q

who are internal stakeholders

A
  • directly affect the business
  • Have access to internal information that is not publicly available
  • May be involved in the management of the organization
  • Drive the business decisions that move a company forward
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3
Q

who would internal stakeholders include

A
  • Executives (CEO, CFO, COO, etc.)
  • Management team (directors, managers, etc)
  • Board of Directors
  • Private investors
  • Employees
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4
Q

who are external stakeholders

A
  • are affected by the business
  • Do not have knowledge of internal information
  • Information is not publicly available
  • Impacts company decisions to a degree (depending on the type of stakeholder)
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5
Q

who does external stakeholders include

A
  • Lending institutions (banks, credit unions, etc)
  • Governments (federal, provincial, and municipal)
  • Regulatory bodies
  • Vendors / suppliers
  • Competitors
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6
Q

who are public shareholders

A
  • Entities (people or corporations) that have an ownership stake in the business resulting from the purchase of company shares through public markets
  • Can own an extremely small piece of the company (ex. 0.00001%) or a big chunk (ex. 25%)
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7
Q

who are market analysts

A

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

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8
Q

how do market analysts affect a company

A
  • Predictions are publicly available
  • Often indirectly affects the market value of the companies they make predictions about
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9
Q

what is usually a top priority for public companies

A
  • Satisfying shareholders
  • Always think of them when making strategic business decisions
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10
Q

what are public/capital markets

A

Facilitate a mutually beneficial exchange between those who have capital and those who want or need capital

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11
Q

why do public/capital markets exist

A
  • Companies want/need money
  • investors have money
  • Each party will get what they want and benefit in the process
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12
Q

who are investors in capital markets

A
  • investors
  • They represent those with available capital that gives to those who want/need it (ex. Public companies), and receive shares to represent their ownership in the company
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13
Q

what are the ways investors expect a return from when investing

A
  • share price appreciation
  • dividends
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14
Q

what is share price appreciation (simple explaination)

A

When the price of the shares in the capital markets increase over time, and can be sold for higher than it was bought for (for a profit)

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15
Q

what are dividends

A

When the company chooses to return profits they make to the shareholders through consistent payment

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16
Q

how does share price of a company change

A
  • Earning potential of a company = their ability to generate future earnings
  • Public companies are judged by their earning potential
  • Company value is determined by the present value of a company’s future cash flows
  • Investors try to predict the future earnings of a company & determine their worth today
  • The predictions drive the company’s share price
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17
Q

how could investors opinion change the share price of a company

A
  • If investors think the company has a strong positive future, the share price could rise
  • If the investors think the company will face hardships in the near future, the share price could fall
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18
Q

how can market analysts affect the share price of a company

A
  • Market analysts affect this process, making public predictions about a company’s earnings every quarter
  • Since public companies report their earnings quarterly, analysts can compare their expectations to the actual results
  • If company results > analyst expectations = share price increases
  • If company results < analyst expectations = share price decreases
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19
Q

what is the Market Value (of company shares)

A

The price of shares based on what the market believes the company is worth

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20
Q

are changes in the market value of shares recorded on the balance sheet

A

no

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21
Q

what is the Book Value (of company shares)

A
  • Net asset value (total assets - total liabilities) on a per-share basis, that is recorded on the equity section of the statement of financial position (also total equity available to shareholders / number of shares outstanding)
  • The actual line items of the shares show the initial cost of the shares
  • The market value is almost always different from the book value
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22
Q

what is the journal entry to record the sale of shares

A

DR cash
CR common shares/share capital/stock

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23
Q

how does dividends impact whether an investor invests in a company

A
  • Investors invest if they think they would earn consistent or even increasing dividends
  • Investors might invest if they would get dividends or if they would get dividends and think that there would be share price appreciation
  • Depends on investor preference
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24
Q

if a company chooses to pay dividends, when is it usually done

A
  • quarterly
  • sometimes monthly or semi-annually
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25
Q

can a company decide to stop giving out dividends if they gave it out before

A

they can decide to stop mid-way, but it wouldn’t look good on the public markets

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26
Q

what is the journal entry to record dividends

A

DR Dividends (SE)
CR Dividends Payable (L)

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27
Q

what is the journal entry for when dividends are paid

A

DR Dividends Payable (L)
CR Cash (A)/Common Shares/Share Capital (SE)
- Credit common shares/share capital when stock dividends are given instead of cash
- Stock dividends are just additional shares of the company given instead of cash

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28
Q

when does an IPO happen

A

after:
- seed investments (from friends and family)
- angel investment
- venture capitalists
- private equity investments
- bank financing

or simply if a company wants to go public

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29
Q

how are shares divided when a company is just starting (as private)

A
  • owners inject capital (cash) into the organization for shares
  • They deposit money into the corporate bank account & receive a share certificate for their portion of the total shareholding
  • If no new/additional shares were issued & no shares were bought back, the common share line item on the balance sheet will always = the amount of cash injected to start the company
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30
Q

how are changes in common share balance shown & where

A
  • on a note to the financial statements
    Rows:
  • As at end of previous period
  • additional shares issued
  • shares repurchased
  • as at end of period

Columns:
- number of shares
- value ($)

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31
Q

what is an IPO

A

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

32
Q

what is it like to issue an IPO

A
  • Process is lengthy and complex
  • Time extensive & expensive to go public
33
Q

which parties are involved when a company decides to go public

A
  • Investment banks
  • Lawyers
  • Auditors & Securities exchange experts
  • Regulators
34
Q

what do investment banks do when a company decides to go public

A
  • Play a critical role in pre-marketing the IPO to large authorized private & institutional investors
  • Influence the demand and initial price of the shares at the time of the IPO
35
Q

what do lawyers do when a company decides to go public

A

Help facilitate the transactions

36
Q

what do auditors & securities exchange experts do when a company decides to go public

A

Ensure all accounting records & paperwork are appropriate based on the requirements

37
Q

what is a common misconception about IPOs

A

That retail investors (like you) can buy IPO shares (can happen, but really rare)

38
Q

what is the process of purchasing shares from a company (starting from IPO shares)

A
  • Large private & institutional investors buy the IPO shares directly from the company in large quantities (primary market)
  • Retail investors can only buy IPO shares if an investment broker is an institutional investor & decides to sell their shares to the public
  • Then retail investors buy it from the private & institutional investors (secondary market)
  • Price is usually higher than the IPO price (private & institutional investors want to make a return)
39
Q

what is the difference between IPO share issuance and share issuance in a private company

A

that the price is determined by the primary market

40
Q

how is the common share balance on the balance sheet calculated

A

of shares sold x price

41
Q

what happens to the common share balance on the balance sheet when all IPO shares are sold

A
  • the balance does not change (even when the market price of the shares change)
  • only changes if more shares are sold
  • or if the company repurchases previously issued shares
42
Q

what is it called if a company decides to give out more shares after their IPO

A
  • Seasoned equity offering
  • follow-on public offering
43
Q

what are the different types of shares

A
  • common shares
  • preferred shares
44
Q

what are the characteristics of common shares

A
  • commons
  • all companies have them
  • Issued when a company is first established + at IPO time
  • Usually 1 vote per share
45
Q

what are the characteristics of preferred shares

A
  • preferreds
  • Typically, no voting rights
  • Guaranteed indefinite dividends
  • Closer to the front of the line upon company liquidation
46
Q

what are cumulative preferred shares

A
  • a class of preferred shares with special dividend rights
  • Legally entitled to receive dividends every year (arrears)
  • The company may not pay you every year, it just becomes a liability for them
  • If you didn’t get paid dividends from before, they will give you the total amount they missed
  • Also ahead of any dividends being paid to common shareholders
47
Q

what are non-cumulative preferred shares

A
  • another class of preferred shares without special dividend rights to receive dividends in arrears
  • Company has no legal obligation to pay them dividends every year
  • Can choose to pay dividends or not (if they operated on a loss that year, they might not)
48
Q

what can companies do with different classes of stocks

A
  • Common & preferred stock can have multiple classes issued
  • Ex. Class A common shares, Class B common shares, Class A preferred shares, etc.
  • Company can decide on rights & limitations of each class of shares
49
Q

what is a common reason why different classes of shares are created & issued

A
  • companies want voting power to remain with a particular group
  • Issuing multiple classes of shares can structure voting rights to ensure other parties don’t accumulate too much voting power or even potentially take over the company
50
Q

what are examples of classes of shares

A

can be common or preferred
- Redeemable shares
- Callable shares
- Convertible shares

51
Q

what are dividends (definition)

A

The distribution of a company’s earnings to its shareholders

52
Q

how are dividends distributed

A
  • Often distributed quarterly (sometimes annually)
  • Can be paid as cash (cash dividends) or by issuing more shares to the company’s shareholders (stock dividends)
53
Q

what is a requirement if a company is paying dividends

A
  • Company must have enough retained earnings and cash to pay cash dividends
  • If they don’t have enough cash but want to give out dividends, they can give stock dividends
54
Q

what are the steps/dates for if a company wants to pay a cash dividend

A
  1. declaration date
  2. record date
  3. payment date
55
Q

what happens on the declaration date

A
  • BOD approve & declare a dividend
  • Dividend becomes a legal liability on this date
56
Q

what is the journal entry for when a dividend is declared

A

DR retained earnings
CR dividends payable

57
Q

what happens on the record date

A
  • Company prepares a list of current shareholders
  • Only those that own shares on the declaration date
  • No journal entry
58
Q

what happens on the payment date

A

Payment of dividends is recognized

59
Q

what is the journal entry for when dividends are paid

A

DR dividends payable
CR cash

60
Q

what are dividends like on preferred shares

A

are usually an annual dollar figure (per share) or annual dividend % (dividend yield)

61
Q

what is dividend yield

A

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

62
Q

how is preferred share dividends calculated if it is communicated as an annual dollar figure (per share) if it is 200,000 shares of $4 cumulative preferred shares outstanding

A
  • Every shareholder gets $4 per share they hold annually
  • If paid quarterly: $4 / 4 quarters = $1 per share quarterly
  • If cumulative, they get paid prior period dividends if were not declared/missed in prior periods
63
Q

how is preferred share dividends calculated if it is communicated as a dividend yield if it is 200,000 shares of non-cumulative preferred shares outstanding & issued at a par value of $50 per share & dividend yield is 6%

A
  • $50 x 6% = $3 per share annually
  • If paid quarterly: $3 / 4 quarters = $0.75 per share quarterly
  • If not cumulative, will not get paid prior periods
64
Q

what are dividends in arrears

A

When a company with cumulative preferred shares has missed dividend payments that will be paid next time dividends are declared

65
Q

how dividends are divided & allocated to preferred and common shareholders

A
  1. Calculate the dividend to be paid to preferred shareholders (including any preferred dividends in arrears)
  2. Assign remaining dividends to common shareholders
66
Q

what are the options for a company if they need more capital (after an IPO)

A
  • seasoned equity offering
  • debt
  • equity
67
Q

what are the pros of a company taking on more debt to finance their operations

A
  • 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
68
Q

what are the cons of a company taking on more debt to finance their operations

A
  • 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
69
Q

what are the pros of a company taking on more equity to finance their operations

A
  • No legal requirement of continuous repayment
  • Less restrictive on the use of funds
70
Q

what are the cons of a company taking on more equity to finance their operations

A
  • Dilution of ownership/control
  • Higher 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.
71
Q

what does a company also need to consider when getting more financing

A

weighted-average cost of capital

72
Q

what is Weighted-Average Cost of Capital (WACC)

A
  • The cost to acquire additional financing, fluctuating depending on the level of debt vs. equity a company holds
  • Expressed as a %
  • Changes based on how the proportion of debt to capital changes
73
Q

what do companies try to do with WACC

A

try to minimize it

74
Q

how do companies try to minimize their WACC

A
  • they calculate how WACC changes if they take on more debt vs more equity
  • Outcome affects their financial decisions along with qualitative factors
75
Q

what is another form of debt corporations can have

A
  • Corporations can issue bonds as a form of debt
  • Bond markets exists to exchange debt
  • Global bond markets are much larger than global stock markets
  • Corporations can sell bonds on bond markets in exchange for cash with the promise to repay with interest (instead of ownership in the company)
76
Q

how to calculate WACC if you have debt for $10M @ 10%, equity for $10M at 15%

A
  • total amount of financing = $20M
    = (50% x 10%) + (50% x 15%) = 12.5% -> means you need to make at return of at least this amount, otherwise, you would be operating on a loss
  • ^ 50% because debt and equity both make up half of the total $20M

AFM 182 (11 decks)

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