Topic 6: Conventional Sources of Finance Flashcards
What is equity finance? and what are the 3 main sources?
It is the method of selling shares to raise capital and investors get an ownership share and voting rights, investors expect capital appreciation and dividends.
What are the the 3 sources of equity finance and what are the advantages and disadvantages of each?
1.) Retained earnings -
Positives:
- Cheap
- Easy accessible.
Negatives:
- Shareholder unhappy as that is their dividends pot
- It has a limit, companies dont have unlimited profits.
-profit isnt cash, can be profitable but have no money.
2.) Rights issue
Postives:
- Cost less that new issue as it doesnt have to be advertised – - - Underwriting, even at a lower price it costs less than adveritising new shares.
- Ownership proportions stay similar.
Negatives:
- Shareholders may not have the funds to buy rights issue.
- Shareholders may sell right issue, diluting shares.
3.) New share issue
Positives:
-Maximisation of proceeds as no discounts and bigger buyer base.
Negatives:
- Higher cost
- Difficult to set price.
What are the 3 ways to sell new issue of shares?
Offer for sale at set price.
Offer for sale by tender - invites potential investors to bid
Placing - Not offered to the public but placed on sponsoring market where a small amount of instutions can buy (Pre-arranged).
What are the 3 main factors to consider when setting up a rights issue?
Cost, Quanitity, Terms of service.
How to calculate the terms of issue of a righst issue?
Number of right shares issued compared to existing shares that are in issue.
How to calculate Theoretical Ex-Right Price (TERP) and what is TERP used for?
This is to calculate the share price immediately after a rights issue.
TERP = )Total market value of shares pre-rights + Proceeds from right) / Total number of shares in issue after rights.
How to calculate the value of a right? and value of a right per share?
Value of a right = TERP - Right issue price.
Value of right per share = (TERP - Right issue price) / Number of shares needed to obtain right.
How to calculate the change in a individual wealth after a rights issue, if they do any of the 3 options available to the individual?
1.) Buy share calculation - (Number of shares after righst issue x Terp) - (Number of Right issue shares purchased x issue price)
2.) Selling Shares Calculation - (Number of shares held after rights issue x Terp) + (Number of rights sold x Value per share).
3.) Do nothing Calculation - Number of shares held after rights Issue x TERP.
How does an individual sell the rights issue shares?
They can be traded the same as any ordinary shares.
What are the ways to list shares on the stock market? and what are the advantages and disadvantages of list shares?
1.) Initial public offer (IPO) - Most common, can do sale by tender and sale at fixed price
2.) Placing - Not public, insitutions only, on sponosred market.
3.) Introduction - Company is already on different stock exchange but wants more options so joins another exchange
Positives:
Wider pool
Enhances reputation - gets your name more recognised.
More market value shares
More tradeable.
Negatives:
Listing is expensive
Greater regulation, accountability, scrutiny.
What are bonus shares? and what is the other name for it?
Shares are given away to existing shareholder at the proportion they already own also called script issue
What are the types of long term finance? and explain them.
Bank loan - Receiving an lump sum amount of money and paying it back incremental payments plus interest.
Bonds - They are issued by companies and counties and set $100 nominal and the holder receives a fixed interest every period (Month or year) and they can be traded and there is a redemption time where the nominal value is paid back.
What are the different names for bonds and what are the specific characteristics of a bond
Deep discount - Low coupon rate, Sold below nominal value and redemption is higher than nominal.
Zero Discount - No coupon rate, sold alot lower than nominal valeu and sold well above nominal.
Convertible - The investor has a right to convert the bonds into other sercurities e.g shares
How to calculate conversion premium?
Market value of bond - value of shares if converted today = Conversion premium.
What are the Positives and Negatives of long term finances?
Positives:
Certainty of future cashflow - fixed interest rate.
Tax relief - on interest payments which you can’t get on dividends which means it is better than equity.
Negatives:
Convenants - Providers can set goals
Risk of bankrupcy increased because its debt.
What are the different types of medium finance?
Preference shares - Fixed dividends and no ownership.
Leasing - the use of an asset without owning it.
Venture capital - investing
What is the dividends decision? and what are the relevant theories?
It is the decision about how much of earnings to pay out as dividends versus retaining and reinvesting earnings in the firm.
Modigliani and Millers irrelevancy theory - in a perfect market (Perfect info, no transaction costs or tax) shareholders wouldnt care if they got dividends as it would be reflected in their capital wealth.
Residual dividends theory - All projects with NPV should be paid out of retained and the result is shared out as a dividend
Dividends relavance theory:
-Dividends signalling - If dividends go down investors can think something is wrong.
- Clientele effect - changing dividends could affect tax planning
- Preference for cash income.
What are the alternative ways to pay dividends without cash?
Script Dividends - Shares given to shareholders instead of dividends to increase shareholding.
Share repurchase - buying shares from shareholders because they have alot of cash and rather moeny stays in the business for longer.
What are the different types of short term finance?
Overdraft - allows negative balance but high interest.
Short term loan - to support day to day trading.
Trade credit - have goods now, pay later.
lease - using asset but not own.
What are the arguements for and against overdraft and short term bank loan
Positives:
Flexible - Take what you need
Ease - easy to arrange compared to long term options
Negatives - Repayble of demand whereas bank loan is pre-set
