Chapter 8 Flashcards
Main internal source of finance
Retained earnings
Main internal source of finance
Retained earnings
Ways to improve working capital management
Reducing the time taken to receive payments from customers (e.g. by offering discounts for quick payment or outsourcing debt collection to a factor).
Reduction in the amount of inventory (e.g. through improved supply chain management or even moving to Just-in-Time (JIT) production).
Taking increased credit from suppliers. However, care must be taken not to lose settlement discounts or compromise relationships with key suppliers.
Rights issue
the existing shareholders are offered more shares (usually at a discount to the current market price) in proportion to their existing holding
Pre emptive rights
the right to purchase new shares before they can be offered to other investors). This is to protect shareholders from dilution of their control.
What is theTERP - theoretical ex rights price
The expected share price following the rights issue
Points to note for the calculation of the TERP per share
Proceeds of the rights issue should be added net of any issue costs.
If the project has already been announced, and if the market is operating at the semi-strong level of efficiency, the project’s NPV will already be reflected in the existing share price and it should not be included again in the formula above.
Formula for TERP
the fraction with numerator Pre minus existing value of equity plus proceeds of rights issue plus project NPV and denominator Number of shares after the rights issue
Methods of issuing shares
Offer for sale
Placing
Rights issue
Offer for subscription
Offer for sale or subscription by tender
Offer for subscription
A direct sale to the general public. This is generally the most expensive method of issuing new shares.
Offer for sale
An indirect sale to the public accomplished by selling shares directly to an issuing house (merchant/investment bank), which then sells them to the public
Placing
In a placing, the sponsor (normally a merchant bank) places the shares with its clients (usually pension funds and insurance companies) rather than the shares being offered to the general public. This is generally the least expensive method of issuing new shares.
Rights issue
An offer to allow existing shareholders to buy new shares in proportion to their existing holdings.
Offer for sale or subscription by tender
Like an auction, with the public being invited to bid for shares. Useful where setting a price for the shares is difficult.
Options for unquoted companies
To become quoted (i.e. raise new equity finance at the same time as becoming listed). This is known as an initial public offering (IPO). The method could be an offer for subscription or sale, tender, or placing. It is an expensive process.
To stay unquoted. Use a rights issue or private placing. However, there may be a limited source of funds from either existing owners or new private investors.
To engage in what is known as “introduction”.
No shares (neither existing nor newly-created) are made available to the market, so no new finance is raised.
Stock market grants a quotation, given that shares must already be widely held, so that a market can be seen to exist.
Why do ordinary shareholders take more risk
ordinary dividends are discretionary (i.e. the company has no legal obligation to pay an ordinary dividend); and
ordinary shareholders rank last in the event of bankruptcy/liquidation.