Shareholders

Question 1

Share Definition

Answer 1

Shares represent the proportion of a company owned by an investor. Also called equity.

Question 2

Proportion of Business Owned

Answer 2

No. of shares owned
——————————- x 100 = % owned
Total shares issued

Question 3

Ordinary vs. Preference Shares

Answer 3

Ordinary shares get voting rights and a dividend

Preference shares get a set dividend amount before ordinary shares get theirs. No voting rights.

Question 4

Shareholder Objectives

Answer 4

Main objective for most private companies is to maximise the wealth of its shareholders.

Done by maximising profits and either paying dividends or reinvesting profits into the business to raise share price.

Question 5

Return on Capital Employed (ROCE)

Answer 5

Shows how efficient a company is at generating profits from the amount invested.

Shareholders compare ROCE to their expectations in order to make investment decisions

Question 6

ROCE Formula

Answer 6

Profit before interest and tax
—————————————— x 100%
Total assets - current liabilities

Question 7

ROCE for Investment Decisions

Answer 7

ROCE is above expectation:
Yes - invest
No - consider alternatives

ROCE is higher than an alternative investment:
Yes - invest
No - move money

Question 8

ROCE Failures

Answer 8

Doesn’t take into account where profits go. If ROCE is high, but tax and interest are too, dividend will be smaller than expected

Question 9

Earnings Per Share (EPS)

Answer 9

EPS calculates potential dividend payout per share.

Actual dividend may be lower if the directors decide to reinvest profit .

Question 10

EPS Formula

Answer 10

Number of outstanding ordinary shares

Question 11

Long Term Shareholder Wealth

Answer 11

To calculate expected return over a given period, a shareholder could total up expected:

• dividends over the period; and
• increases in price per share

Question 12

Issues with Expected Returns

Answer 12

Estimated values may differ from actual values

Doesn’t take cost of capital into account

Shareholder may not know their cost of capital - return level required

Ignores the time value of money

Secure more jobs

Question 13

Net Present Value

Answer 13

Alternative approach. Works out the value of the company.

Based on cash flows (increased cash flows = increased value)

Takes into account cost of capital and time value of money

Question 14

Factors Affecting Long Term Value of Shares

Answer 14

Internal factors: things the company does

External factors: things competitors/outsiders do

Financial factors: company financial results

Market expectations, positive and negative info also affect share value

Question 15

Risk and Return - Types of Risk

Answer 15

Systematic: uncertainty inherent to a particular market, e.g. the property market

Unsystematic: uncertainty inherent to a company

These risks are avoided by investing in a bank instead of shares.

Question 16

Banks vs. Shares

Answer 16

Banks:

• Interest consistent and guaranteed
• Investment in the bank stays the same
• Often guaranteed by the government

Shares:

• Annual dividends will vary each year
• Market value of shares varies
• Investors lose full investment if co closes

Question 17

Risk vs. Return - Risk Free Rate

Answer 17

Rate of return which would satisfy investors if they were guaranteed a return e.g. at a x% return, risk is 0 on the graph.

Based on:
Rate required to compensate being unable to spend the money now; and
Rate of inflation

Question 18

Factors Affecting Risk and Return

Answer 18

Company Strategy

• Returns may be low if profits reinvested
• Shareholders may accept lower short term returns for high returns following investment

Question 19

Factors Affecting Risk and Return

Answer 19

Economic Conditions (During Recession)

• Profits fall so investing is riskier, investors expect a higher return
• Returns available fall so investors may accept lower levels of returns

Question 20

Factors Affecting Risk and Return

Answer 20

Expectations About the Industry

- High returns in one industry push up rate of returns across the whole industry, so expectation rises.

Question 21

Shareholder Impact on Management

Answer 21

Management have to keep shareholders happy to ensure continued investment.

Question 22

Dividend Policy

Answer 22

Determination of how much and how often cash is paid out of profits as dividends.

Every policy must consider the other financial needs of the business as well as:

• Shareholder cost of capital; and
• Level of risk shareholders want to take

Question 23

Signalling

Answer 23

Dividend announcements convey information to the market affecting share prices.

Management will tend to choose projects which promise positive announcements.

Question 24

Shareholder Communication

Answer 24

To limit negative reactions from assumptions, organisers can keep contact with shareholders through:

• Holding shareholder meetings
• Communicating all project decisions
• Communicating all dividend announcements