Topic4- Equity Financing

Question 1

What do ordinary shareholders have?

Answer 1

• Have voting rights

- share in profits of the company (dividends)

Question 2

What are dividends?

Answer 2

• shares in profits of the company

- The company has no obligations to give out dividends unless already declared

Question 3

What’s the difference between bond holders and shareholders?

Answer 3

• Bondholders take less risk, they have a legal contract to ensure they get their payment
• Shareholders require more return as they take the most risk, as they are given the smallest share of the profits

Question 4

What is the claim on profits queue?

Answer 4

1) Debt Holders
2) Preferred Stock Holders
3) Equity Holders

Question 5

Why do companies like to keep dividends stable?

Answer 5

Companies like to keep dividends stable (dividend smoothing) & only make gradual increases because otherwise this might create high expectations that the company cannot fulfill in the future which would then reflect badly on the company.

• The markets react positively to dividends being paid

Question 6

What is share premium?

Answer 6

The difference between market price & par value

Question 7

What is rights issue?

Answer 7

Right of existing shareholders to issued shares before offering to outsiders

Question 8

What is script issue?

Answer 8

Issued to bring down the price and give shareholders more shares

Question 9

What is share split?

Answer 9

Reduces par value of shares and increases the overall number of shares

Question 10

Why reduce the market price of shares?

Answer 10

Makes the share more liquid (easier to buy) for smaller investors

Question 11

What do preferences shareholders get?

Answer 11

• When it comes to profits, preference shareholders don’t have preference
• More risky than bond/debt therefore cost of preference shares is a lot higher

Question 12

Why is valuation of shares so important?

Answer 12

Management- Essential for decision making to ensure the maximization or shareholders wealth

Investors- Allows them to estimate value of shares, so they are able to invest their money more carefully

Question 13

What are the 3 main methods of share valuation?

Answer 13

1) Net Asset Value
2) Price Earnings Ratio
3) Dividend Valuation Models

Question 14

What is net asset value?

Answer 14

• Concerned with boom value of assets

- Calculated by taking away total liabilities from total assets

Question 15

What are advantages and disadvantages of net asset value?

Answer 15

Advantages:
- Helpful when firm is in financial trouble

Disadvantages:

• Are accounts reliable?
• Valuable employees not included in assets
• Ignores future potential of company

Question 16

What is price earning ratio?

Answer 16

• Popular approach

- High PE companies= More future growth, therefore more attractive to investors

Question 17

What are advantages and disadvantages of price earning ratio?

Answer 17

Advantages:

• inputs easily available for public firms
• easy to calculate & understand

Disadvantages:
- Uses accounting numbers (therefore must be careful) as numbers can change depending on accounting principles