Sources of Corporate Finance: Equity

Question 1

Equity Finance

Answer 1

• External long-term finance
• Holders of equity finance are the owners of the company
• They have a right to the residual cash flows
• Can be listed or unlisted

Question 2

Ordinary Shares

Answer 2

• Ordinary Shares are issued by the company and are held by investors/ shareholders
• If the company does well there are no limits to the size do the claim equity shareholders have on profit

Question 3

Disadvantages of Ordinary Shares

Answer 3

• Issuing shares is a costly business ( share investors require higher rate of return and the transaction costs of the issue process can be high)
• Issuing shares to external investors may mean loss of ultimate control of the company by the current dominant shareholder

Question 4

Nominal Value

Answer 4

• The nominal value of a share is decided and set by the company
• Shares are usually issued at a premium
• Premium = Issue Price - Nominal Value

Question 5

Benefits of a well-run stock exchange

Answer 5

• Firms can find funds and grow
• Allocation of capital
• For shareholders
• Mergers
• Status and publicity
• Improves corporate behaviour

Question 6

UK Corporate Governance Code

Answer 6

• Transparency
• Accountability
• Integrity
• Internal Control
• Risk Management
• Reporting to shareholders

Question 7

Pros of Listing IPO

Answer 7

• Exit route for current owners
• Uses shares to acquire other companies
• Access to finance
• Increase and improve company profile

Question 8

Cons of Listing IPO

Answer 8

• Costs of listing
• Shareholder expectation
• Short termism
• Public Scrutiny
• Open to takeover bids

Question 9

Buying and selling shares after issue by company

Answer 9

• Traded by shareholders via a stock exchange
• Market value of shares will depend on supply and demand as well as company/ industry performance
• If capital market is efficient the quoted price of the share will reflect market expectations about the value of the share based on its future performance
• Market value does not equal nominal value

Question 10

EQUITY vs Debt

Answer 10

• Controls company
• Has a vote
• Owns retained profit
• Dividends paid from profit after tax

Question 11

Equity vs DEBT

Answer 11

• A contract with the company
• Receives interest
• Receives repayment principal
• Interest is a business cost and is tax-detectable

Question 12

How does company decide?

Answer 12

• Amount of finance required
• Period finance is required for
• Cash flow available to repay
• Alternative uses of internal resources
• Availability of finance
• Cost of finance
• Dividend policy
• Cost of raising finance

Question 13

Bonds and Equity compared

Answer 13

• With a bond you are promised a return
• Less risk= the right to receive the annual interest before the equity holders receive any dividend, rights to seize company assets
• Bond holders do not share the increase in value created by an extraordinary successful business
• Absence of any voting power over the management of the company
• Referred to collectively as fixed-interest securities