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Financial Management ACCA > Chapter 7 - Sources of finance > Flashcards

Chapter 7 - Sources of finance Flashcards

1
Q

What are the three main sources of equity finance?

A
  1. Retained earnings – using internally generated funds
  2. Rights issues
  3. New issues to external shareholders
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2
Q

What are the 3 main factors to consider/calculate with regards to a rights issue?

A
  • Issue price
  • Issue quantity
  • Terms of issue (1 for 5)
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3
Q

What is the Theoretical Ex-Rights Price (TERP)?

A

This is the expected share price for all of the shares after the rights issue has taken place

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4
Q

TERP formula

A

𝑇𝐸𝑅𝑃 = ((π‘šπ‘Žπ‘Ÿπ‘˜π‘’π‘‘ π‘£π‘Žπ‘™π‘’π‘’ π‘œπ‘“ π‘ β„Žπ‘Žπ‘Ÿπ‘’π‘  π‘Žπ‘™π‘Ÿπ‘’π‘Žπ‘‘π‘¦ 𝑖𝑛 𝑖𝑠𝑠𝑒𝑒) + (π‘π‘Ÿπ‘œπ‘π‘’π‘’π‘‘π‘  π‘“π‘Ÿπ‘œπ‘š 𝑛𝑒𝑀 π‘ β„Žπ‘Žπ‘Ÿπ‘’ 𝑖𝑠𝑠𝑒𝑒)) Γ·
(π‘›π‘’π‘šπ‘π‘’π‘Ÿ π‘œπ‘“ π‘ β„Žπ‘Žπ‘Ÿπ‘’π‘  𝑖𝑛 𝑖𝑠𝑠𝑒𝑒 π‘Žπ‘“π‘‘π‘’π‘Ÿ π‘‘β„Žπ‘’ π‘Ÿπ‘–π‘”β„Žπ‘‘π‘  𝑖𝑠𝑠𝑒e)

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5
Q

How do you calculate the value of a right?

A

TERP - Right issue price

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6
Q

What are the three options for an investor when there is a rights issue?

A
  1. Sells Rights
  2. Do Nothing
  3. Takes up the rights
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7
Q

What are three ways a company can issue new shares to new shareholders?

A
  1. Offer for Sale at a fixed price
  2. Offer for sale by tender
  3. Placing
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8
Q

What are three Methods of Obtaining a Stock Market Listing?

A
  1. Initial Public Offering
  2. Placing
  3. Introduction
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9
Q

Initial Public Offering (one point)

A

This involves offering shares for sale at a fixed price or offering shares for sale by tender.

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10
Q

What is Placing (two points)

A
  • The shares are sold to a small number of institutional investors
  • Unlikely that all of the shares will be placed
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11
Q

Introduction

A

-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.

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12
Q

What are the five advantages of having a stock market listing?

A 
β–ͺ Access to a wider pool of finance
β–ͺ Easier to seek growth by acquisition
β–ͺ Original owners can realise their investment
β–ͺ Enhanced public image
β–ͺ Improved Marketability of Shares
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13
Q

What are the two disadvantages of having a stock market listing?

A

β–ͺ Significantly greater public regulation, accountability & scrutiny
β–ͺ Additional costs in regard to new share shares

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14
Q

What are the two main types of long term debt finance?

A

Bank borrowings

Issuing of bonds

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15
Q

What are the two main considerations when issuing debt?

A
  1. Debt interest is tax deductible. Debt is therefore β€˜cheaper’.
  2. Debt holders rank before equity holders in the event that the company is would up. Increasing levels of debt therefore increase the risk
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16
Q

What are the three secondary considerations when issuing debt?

A
  1. Security - fixed or floating charge
  2. Term of loan - redeemable or irredeemable
  3. Interest – fixed or floating (variable)
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17
Q

What type of debt are bonds?

A

Marketable debt

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18
Q

What does Marketable debt mean?

A

It can be traded on stock markets.

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19
Q

Debenture, loan notes or loan stock are alternative names for what?

A

Bonds

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20
Q

What is the nominal value of a bond?

A

The nominal value is 100 (whether it be pounds, dollars, euro etc.)

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21
Q

Can the market value of a bond be different from the nominal value?

A

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

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22
Q

How is interest calculated on a bond?

A

As a percentage of the nominal value e.g. 6% x $100 =$6

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23
Q

Are bonds redeemable or irredeemable at a future date?

A

Can be either

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24
Q

What are the three extra types of bonds?

A
  1. Deep Discount Bonds
  2. Zero Coupon Bonds
  3. Convertible Bonds
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25
Q

What price are deep discount bonds issued at?

A

The bonds are issued at a price below nominal value

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26
Q

What price are deep discount bonds redeemable at?

A

Redeemable at par or above par at maturity

27
Q

What do deep discount bonds assist with?

A

Short term cashflow

28
Q

What kind of interest rate do deep discount bonds carry?

A

A low rate of interest

29
Q

What price are zero coupon bonds issued at?

A

At a discount to their nominal/redemption value

30
Q

What kind of interest rate are zero coupon bonds charged at?

A

No interest is charged on the bond.

31
Q

What do lenders need from a zero coupon bond?

A

The original rate of discount must offer a high yield to be worthwhile.

32
Q

What do convertible bonds give the holder the right to do?

A

Give the holder the right to convert the bond to other securities, (normally ordinary shares) at a pre-determined price/rate and time.

33
Q

What is the conversion premium?

A

The difference between the market value of a convertible bond and the value of the shares if conversion takes place immediately into ordinary shares.

34
Q

What do companies aim to do with conversion premium?

A

Maximise it

35
Q

How risky are preference shares?

A

More risky than equity but less risky than debt

36
Q

What are two advantages of a bank overdraft?

A

β–ͺ Flexible

β–ͺ Quick to obtain

37
Q

What are two disadvantages of a bank overdraft?

A

β–ͺ Repayable on demand

β–ͺ Interest rate may vary & may be high especially if the overdraft is unsecured

38
Q

What are two advantages of a bank term loan?

A

β–ͺ The exact re-payment schedule, and interest is known.
β–ͺ The company do not have to worry about a withdrawal of funds, as long as they stick to
capital and interest re-payments.

39
Q

What are two disadvantages of a bank term loan?

A

β–ͺ Loan covenants are often required and need to be adhered too.
β–ͺ If gearing reaches high levels, then this will increase the risk of bankruptcy.

40
Q

What are two advantages of trade credit?

A

β–ͺ A β€˜free’ source of finance

β–ͺ Quick to obtain

41
Q

What are four disadvantages of trade credit?

A

β–ͺ Harder to get credit from new suppliers
β–ͺ Credit rating may be affected
β–ͺ Supplier may refuse to supply in the future
β–ͺ Supplier relationships may become damaged

42
Q

Explain Sale and leaseback

A

A company owns an asset
It sells the asset to another company
The original owner then leases the asset back from its new owner

43
Q

What are two advantages of Sale and leaseback?

A

β–ͺ Significant initial cash inflow

β–ͺ Meaning the cash can be invested in projects that yield a high NPV

44
Q

What are three disadvantages of Sale and leaseback?

A

β–ͺ The company loses ownership of the asset
β–ͺ The future borrowing capacity of the company will be reduced.
β–ͺ The company are contractually committed to occupy the premises for a significant amount of time which can be restrictive.

45
Q

What is a eurobond?

A

Any bond issued in a currency outside its country of origin

46
Q

What are SME’s?

A

Small and Medium Sized Entities

47
Q

Give three sources of funding available to SME’s

A
  1. Venture capital
  2. Business angels
  3. Government assistance
48
Q

Who are the typical investors in venture capital?

A

Institutional investors or high net worth individuals

49
Q

What sort of companies do Venture capitalists seek to invest in?

A

Companies with high growth potential

50
Q

Who are business angels?

A

Wealthy individuals who invest in an SME, who are prepared to take high risks for high returns.

51
Q

With an offer for Sale at a fixed price, how are they sold?

A

Either directly to the general public or via an issuing house.

52
Q

With an offer for Sale at a fixed price, why are they expensive?

A

An offer for sale is usually underwritten. This leads to high issue costs, and therefore is expensive.

53
Q

With an offer for Sale at a fixed price, how does control change?

A

β€’ Leads to dilution of control of the existing shareholders.

54
Q

What is difficult about an offer for Sale at a fixed price?

A

Pricing of the shares can prove difficult.

55
Q

With Offer for sale by tender, How does it work?

A
  • 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.

56
Q

With Offer for sale by tender, what does it maximise?

A

β€’ This will maximise the proceeds arising from the issue of new shares.

57
Q

With an offer for Sale by tender, how does control change?

A

β€’ Again, there will be a dilution in control for current shareholders.

58
Q

How does placing work?

A

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

59
Q

How does placing appeal from an administration point of view?

A

β€’ Quick and cheap from an administration point of view

60
Q

With an placing, how does control change?

A

β€’ Again, there will be a dilution in control for current shareholders.

61
Q

What is another name for convertible bonds?

A

Hybrids

62
Q

What is the maturity gap?

A

This is for SME’s

Where they cannot get shorter term loans.

63
Q

What do warrants give the subscriber the right to do?

A

To subscribe at a fixed future date for a certain number of ordinary shares at a predetermined price

Financial Management ACCA (26 decks)

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