Chapter 7 - Sources of finance Flashcards
What are the three main sources of equity finance?
- Retained earnings β using internally generated funds
- Rights issues
- New issues to external shareholders
What are the 3 main factors to consider/calculate with regards to a rights issue?
- Issue price
- Issue quantity
- Terms of issue (1 for 5)
What is the Theoretical Ex-Rights Price (TERP)?
This is the expected share price for all of the shares after the rights issue has taken place
TERP formula
ππΈπ
π = ((ππππππ‘ π£πππ’π ππ π βππππ πππππππ¦ ππ ππ π π’π) + (ππππππππ ππππ πππ€ π βπππ ππ π π’π)) Γ·
(ππ’ππππ ππ π βππππ ππ ππ π π’π πππ‘ππ π‘βπ πππβπ‘π ππ π π’e)
How do you calculate the value of a right?
TERP - Right issue price
What are the three options for an investor when there is a rights issue?
- Sells Rights
- Do Nothing
- Takes up the rights
What are three ways a company can issue new shares to new shareholders?
- Offer for Sale at a fixed price
- Offer for sale by tender
- Placing
What are three Methods of Obtaining a Stock Market Listing?
- Initial Public Offering
- Placing
- Introduction
Initial Public Offering (one point)
This involves offering shares for sale at a fixed price or offering shares for sale by tender.
What is Placing (two points)
- The shares are sold to a small number of institutional investors
- Unlikely that all of the shares will be placed
Introduction
-a company already has a listing on one stock market but wants to also make its shares available for sale on a different stock market.
What are the five advantages of having a stock market listing?
βͺ Access to a wider pool of finance βͺ Easier to seek growth by acquisition βͺ Original owners can realise their investment βͺ Enhanced public image βͺ Improved Marketability of Shares
What are the two disadvantages of having a stock market listing?
βͺ Significantly greater public regulation, accountability & scrutiny
βͺ Additional costs in regard to new share shares
What are the two main types of long term debt finance?
Bank borrowings
Issuing of bonds
What are the two main considerations when issuing debt?
- Debt interest is tax deductible. Debt is therefore βcheaperβ.
- Debt holders rank before equity holders in the event that the company is would up. Increasing levels of debt therefore increase the risk
What are the three secondary considerations when issuing debt?
- Security - fixed or floating charge
- Term of loan - redeemable or irredeemable
- Interest β fixed or floating (variable)
What type of debt are bonds?
Marketable debt
What does Marketable debt mean?
It can be traded on stock markets.
Debenture, loan notes or loan stock are alternative names for what?
Bonds
What is the nominal value of a bond?
The nominal value is 100 (whether it be pounds, dollars, euro etc.)
Can the market value of a bond be different from the nominal value?
Yes. the market value may be different to the nominal value e.g. the market value of a bond might be $95
per $100 nominal value
How is interest calculated on a bond?
As a percentage of the nominal value e.g. 6% x $100 =$6
Are bonds redeemable or irredeemable at a future date?
Can be either
What are the three extra types of bonds?
- Deep Discount Bonds
- Zero Coupon Bonds
- Convertible Bonds
What price are deep discount bonds issued at?
The bonds are issued at a price below nominal value
What price are deep discount bonds redeemable at?
Redeemable at par or above par at maturity
What do deep discount bonds assist with?
Short term cashflow
What kind of interest rate do deep discount bonds carry?
A low rate of interest
What price are zero coupon bonds issued at?
At a discount to their nominal/redemption value
What kind of interest rate are zero coupon bonds charged at?
No interest is charged on the bond.
What do lenders need from a zero coupon bond?
The original rate of discount must offer a high yield to be worthwhile.
What do convertible bonds give the holder the right to do?
Give the holder the right to convert the bond to other securities, (normally ordinary shares) at a pre-determined price/rate and time.
What is the conversion premium?
The difference between the market value of a convertible bond and the value of the shares if conversion takes place immediately into ordinary shares.
What do companies aim to do with conversion premium?
Maximise it
How risky are preference shares?
More risky than equity but less risky than debt
What are two advantages of a bank overdraft?
βͺ Flexible
βͺ Quick to obtain
What are two disadvantages of a bank overdraft?
βͺ Repayable on demand
βͺ Interest rate may vary & may be high especially if the overdraft is unsecured
What are two advantages of a bank term loan?
βͺ The exact re-payment schedule, and interest is known.
βͺ The company do not have to worry about a withdrawal of funds, as long as they stick to
capital and interest re-payments.
What are two disadvantages of a bank term loan?
βͺ Loan covenants are often required and need to be adhered too.
βͺ If gearing reaches high levels, then this will increase the risk of bankruptcy.
What are two advantages of trade credit?
βͺ A βfreeβ source of finance
βͺ Quick to obtain
What are four disadvantages of trade credit?
βͺ Harder to get credit from new suppliers
βͺ Credit rating may be affected
βͺ Supplier may refuse to supply in the future
βͺ Supplier relationships may become damaged
Explain Sale and leaseback
A company owns an asset
It sells the asset to another company
The original owner then leases the asset back from its new owner
What are two advantages of Sale and leaseback?
βͺ Significant initial cash inflow
βͺ Meaning the cash can be invested in projects that yield a high NPV
What are three disadvantages of Sale and leaseback?
βͺ The company loses ownership of the asset
βͺ The future borrowing capacity of the company will be reduced.
βͺ The company are contractually committed to occupy the premises for a significant amount of time which can be restrictive.
What is a eurobond?
Any bond issued in a currency outside its country of origin
What are SMEβs?
Small and Medium Sized Entities
Give three sources of funding available to SMEβs
- Venture capital
- Business angels
- Government assistance
Who are the typical investors in venture capital?
Institutional investors or high net worth individuals
What sort of companies do Venture capitalists seek to invest in?
Companies with high growth potential
Who are business angels?
Wealthy individuals who invest in an SME, who are prepared to take high risks for high returns.
With an offer for Sale at a fixed price, how are they sold?
Either directly to the general public or via an issuing house.
With an offer for Sale at a fixed price, why are they expensive?
An offer for sale is usually underwritten. This leads to high issue costs, and therefore is expensive.
With an offer for Sale at a fixed price, how does control change?
β’ Leads to dilution of control of the existing shareholders.
What is difficult about an offer for Sale at a fixed price?
Pricing of the shares can prove difficult.
With Offer for sale by tender, How does it work?
- Investors will bid for shares at a price of their choice
* All of the shares will then be sold or issued at the maximum price at which all of the shares will be purchased.
With Offer for sale by tender, what does it maximise?
β’ This will maximise the proceeds arising from the issue of new shares.
With an offer for Sale by tender, how does control change?
β’ Again, there will be a dilution in control for current shareholders.
How does placing work?
β’ The shares are not offered to the public, but instead placed on a sponsoring market whereby the shares are sold to a small number of institutional investors
How does placing appeal from an administration point of view?
β’ Quick and cheap from an administration point of view
With an placing, how does control change?
β’ Again, there will be a dilution in control for current shareholders.
What is another name for convertible bonds?
Hybrids
What is the maturity gap?
This is for SMEβs
Where they cannot get shorter term loans.
What do warrants give the subscriber the right to do?
To subscribe at a fixed future date for a certain number of ordinary shares at a predetermined price
