Sources of Finance - Equity

Question 1

Firms need finance to:

Answer 1

Invest in non-current assets
Provide working capital for operations

Question 2

Criteria for choosing type of finance

Answer 2

Cost - debt cheaper than equity
Duration - long-term more expensive, but more secure than long-term
Interest rates - short term usually cheaper but depends on current conditions
Gearing - current gearing level of firm - debt is cheaper but riskier due to repayments, but too much equity means that EPS goes down due to amount of shares issued
Accessibility - ability to get long-term finance

Question 3

Risk versus return

Answer 3

Higher risk taken by an investor requires a greater return, e.g. cost of finance increases

Question 4

Equity choices

Answer 4

Internally generated funds - retained earnings - cheapest (liquidity vs profitability)
Rights issues - cheaper than public share issue, can be made solely by directors, rarely fails
Public share issue - offering

Question 5

TERP

Answer 5

Market value of shares in issue + proceeds of new issue of shares
Divided by:
Number of new shares in issue

Question 6

Value of a right, and per existing share

Answer 6

TERP - issue price of new shares
per existing share, divide by the 2/5

Question 7

Equity Finance

Answer 7

Investment in a company by ordinary shareholders:
Ordinary share capital and reserves

Question 8

Ordinary shares

Answer 8

Rank after all creditors and preference shares. Paid at discretion of directors, right to all retained earnings

Question 9

Cumulative preference shares

Answer 9

Voting rights only at general meeting when dividend in arrears or change of legal rights to the shares, rank after creditors but before ordinary shares.
Fixed amount, arrears accumulate.

Question 10

Non-cumulative preference shares

Answer 10

Some voting rights if dividend not paid in three years. Fixed amount, must be paid, no arrears accumulation

Question 11

Quoted or unquoted shares

Answer 11

Rights issue

Question 12

Unquoted or quoted shares

Answer 12

Public offer/stock exchange or placing from a bank (25% public ownership), public, pension funds, insurance funds

Question 13

Unquoted

Answer 13

private negotiation, e.g. private equity through banks, finance corporations and individual investors

Question 14

Choosing between sources of equity

Answer 14

Accessibility - quoted companies can use any source, unquoted restricted to rights issues and private placings. Could go with a flotation and go public - but expensive
Amount of finance - Limited to the resources of shareholders for unquoted companies, less problematic if can sell the rights
Cost - public issue very expensive
Pricing of the issue - hard to price, can deal with undersubscription, or oversubscription and the benefits going to new investors. Less problematic for rights issues
Control - shareholders will likely want to retain control

Question 15

TERP

Answer 15

Can also be calculated as Market price prior to rights issue - value of a right per existing share

Question 16

Value of a right

Answer 16

TERP - issue price of shares

Question 17

Calculating shares from SoFP

Answer 17

Take ordinary shares and divide by nominal value and then multiply by market rate or share price on announcement