Chp 4: Equity Finance Flashcards
What is a preference share?
Shares carrying a fixed rate of dividend, which enables the holder to have a prior claim to any distributable profits.
What are the advantages of preference shares compared to debt finance and ordinary shares?
Compared to debt finance - PS are more flexible as if we incur losses the dividend does not have to be paid out.
Compared to OS - No dilution of contorl, preference shares normally don’t carry voting rights
What are the disadvantages of preference shares compared to debt finance and ordinary shares?
Compared to DF - No tax relief on dividend payment and a higher return is expected due to the additional risk.
Compared to OS - Less discretion over whether to pay the dividend. It also creates extra risk for the ordinary shareholders as the PS will be paid first
What do the primary capital markets do?
Allow copanies to raise NEW finance by issuing new shares or debt securities. Capital markets make it easier than doing a private placing.
What do the secondary capital markets do?
Allow for the sale nad purchase of existing shares and securities. This increases the marketability of securities to new investors as they know they could sell them on, if they choose to.
What are the three main ways of issuing new shares?
- Initial Public Offer (IPO) - An offer for sale to the public either at a fixed price or by tender
- Placing - Shares are issued at a fixed price to institutional investors
- Rights issue - A legal right for existing shareholders
How does an IPO offer by tender work?
Investors submit their offers to by X shares at a certain price within a designated range. Then all of the shares which have been tendered for at the highest common price (ie. the lowest offer)
If the offer is oversubscribed, then the investors are given the proportionate amount of their share offer. eg. if the offer is oversubscribed by 150%, investors will receive 2/3 of their share offer.
There are three advantages and one disadvantage to a Placing compared ot an IPO. What are they?
Advantages
1. Cheaper
2. Quicker
3.Require less disclosure of information
Disadvantages
1. Most of the shares will be placed with a relatively small number of investors, which will probably prevent trading. Also, the institutional shareholders will have control of the company.
How do you calculate the value of a right?
Formula
(TERP - Issue Price)/
N
N = the number of rights/shares required to buy one share
The value of rights is the theoretical gaina shareholder would make by exercising their rights
How do you calculate Yield Adjusted TERP
Divide the new yield by the old yield and multiply that with the issue price in a standard TERP calculation
Three advantages to a rights issue?
- Cheaper than IPOs - no prospectus required, less admin and cost of udnerwritign will be less
- Relative voting rights unaffected - assuming all rights taken up
- Finance raised can be used to reduce gearing by increasing share capital or paying off long term debt
Three disadvantages to a rights issue?
- Rights issues of unquoted companis are limited by shareholders available funds
- Choosing the best issue price can be tricky
- Market price may fall between the announcement and issue
What are two assumptions for the dividend growth model?
Cost of Equity (Ke)
- Dividend growth can be estimated and is constant
- Dividends are paid and the company has a share price
What is the formula for dividend growth using the current reinvestment levels method?
Formula
return on equity x balance reinvested
return on equity = R, balance reinvested = b and is the non dividend bit
What is unsystematic risk?
Risk that can be diversified away by investing in multiple projects
