Sources of Fianace Flashcards
What is leverage?
Debt is financial leveraging
The hope is that the return on the borrowed money will be high enough to cover the cost of debt and additional profit.
A 5% debenture invested that gets you 9% is good as it covers the 5% to the investor and a return margin of 4%
What are ordinary shares?
Also called “equity shares”-holders are owners of company.
High risk, so high return expected-subordinate to all other finance providers.
Potentially returns unlimited, and..
Control over the business.
Limited loss liability, but ..
Pay dividend at directors’ discretion
For the business: no tax relief on dividends paid
Assume Silva Ltd issues 10,000 new shares for $1.50. The nominal value of the shares is 25 cents. How would this be recorded in the accounts?
DR Cash 15,000
CR Nominal Share Capital 2,500
CR Share Premium 12,500
What are preference shares?
features of a preference share:
Lower risk than ordinary shares
Fixed rate of dividend
Priority over ordinary shareholders if business wound up
Types: cumulative; non-cumulative; participative; convertible.
For the business: similar to loans, but no tax relief on dividends paid, so loans more attractive
What are the two capital / stock markets?
Primary market - enables businesses to raise new capital (both equity or debt)
Secondary market - enables investors to sell their securities (shares and loan capital)
What are the methods of issuing equity?
Equity:
IPO
Placing
Rights Issues
Preference Shares:
(could be classified as debt)
What is an IPO?
Occurs when a company goes “public” by listing on a stock market for the first time
May be completely new shares or may derive from transfer to the public of some or all of the shares already held privately
Shares offered for sale through an issuing house.
Offer could be made either at a fixed price set by the company or in a tender offer.
What is a tender offer?
Is an alternative to a fixed price offer
Subscribers tender for the shares at, or above, a minimum fixed price
Once all offers have been received from prospective investors, the company sets a “strike price” and allocates shares to all bidders who have offered the strike price or more
What are the advantages of listing?
More accurate valuation after listing
Makes shares more marketable
Easier to raise capital in future
Raises company’s profile-credibility with suppliers, financiers.
What are the disadvantages of listing?
high costs of obtaining a listing
closer scrutiny of operations / management
pressure to perform
additional levels of financial disclosure
reporting requirements more onerous
What are rights issues?
New shares offered for sale to existing shareholders, in proportion to the size of their shareholding
‘Pre-emption rights’ to buy ahead of outside investors
Rights issues cheaper than public share issue
Issue price set which is low enough for shareholder acceptance but not too low (to avoid excessive dilution of earnings per share)
Implications for shareholders and the company
What happens to market price after rights issues?
Market price after issue:
Tendency to fall due to
uncertainty about future profits
uncertainty about future dividends
More shares in issues-effect on EPS
New shares issued at discount
What is Cum rights?
Cum rights: the rights attached to existing shares when rights issue is announced.
What is Ex-Rights?
Ex-rights: after new shares are issued, rights no longer exist.
How do you calculate theoretical ex-rights price? (TERP)
(N * Cum)+issue price / N+1
N = number of shares required to be held in order to receive one rights issued share (eg: 1 for 4 rights issue, n=4)
