Topic 6: Conventional Sources of Finance Flashcards

1
Q

What is equity finance? and what are the 3 main sources?

A

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.

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2
Q

What are the the 3 sources of equity finance and what are the advantages and disadvantages of each?

A

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.

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3
Q

What are the 3 ways to sell new issue of shares?

A

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).

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4
Q

What are the 3 main factors to consider when setting up a rights issue?

A

Cost, Quanitity, Terms of service.

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5
Q

How to calculate the terms of issue of a righst issue?

A

Number of right shares issued compared to existing shares that are in issue.

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6
Q

How to calculate Theoretical Ex-Right Price (TERP) and what is TERP used for?

A

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.

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7
Q

How to calculate the value of a right? and value of a right per share?

A

Value of a right = TERP - Right issue price.
Value of right per share = (TERP - Right issue price) / Number of shares needed to obtain right.

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8
Q

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?

A

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.

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9
Q

How does an individual sell the rights issue shares?

A

They can be traded the same as any ordinary shares.

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10
Q

What are the ways to list shares on the stock market? and what are the advantages and disadvantages of list shares?

A

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.

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11
Q

What are bonus shares? and what is the other name for it?

A

Shares are given away to existing shareholder at the proportion they already own also called script issue

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12
Q

What are the types of long term finance? and explain them.

A

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.

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13
Q

What are the different names for bonds and what are the specific characteristics of a bond

A

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

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14
Q

How to calculate conversion premium?

A

Market value of bond - value of shares if converted today = Conversion premium.

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15
Q

What are the Positives and Negatives of long term finances?

A

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.

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16
Q

What are the different types of medium finance?

A

Preference shares - Fixed dividends and no ownership.
Leasing - the use of an asset without owning it.
Venture capital - investing

17
Q

What is the dividends decision? and what are the relevant theories?

A

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.

18
Q

What are the alternative ways to pay dividends without cash?

A

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.

19
Q

What are the different types of short term finance?

A

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.

20
Q

What are the arguements for and against overdraft and short term bank loan

A

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