Week 7 - Valuation of Financial Assets - Shares

Question 1

Ordinary Shares

Answer 1

→ Ordinary Share means that a share of ownership in the firm gives it owner rights to any ordinary dividends and the right to vote on the election or directors and on major events such as mergers
→ Ordinary shareholders are not guaranteed any dividend payments:
- The dividend is based on (1) the profitability of the company and (2) management’s decision as to whether it will pay dividends or retain the firm’s earnings to grow the company
- Thus, dividends will vary with a company’s profitability and stage of growth
Ordinary shareholders have the lowest priority claim on a firm’s assets in the event of liquidation - they have a residual claim on the firm’s assets after paying out all creditors (debtholders) and preference shareholders

Question 2

Preference Shares

Answer 2

→ Preference shares also represent an ownership interest in a firm, but they have preferential treatment over ordinary shares in certain matters
→ Preference share dividend payments are the company’s fixed obligations, similar to interest payments on corporate bonds
→ Preference shareholders are given preference over ordinary shareholders in dividend payments
→ Preference shareholders are also given priority over ordinary shareholders in the event of liquidation
→ They have no voting right privileges
→ Legally, preference shares are equity but often manifest as debt

Question 3

Cumulative preference shares

Answer 3

carry forward any unpaid dividends. So if the company misses dividend payments, it must pay all outstanding dividends to preference shareholders before paying anything to ordinary shareholders.

Question 4

Non-cumulative preference shares

Answer 4

don’t carry forward unpaid dividends. If a dividend is missed, it’s gone. But current dividends are still paid to preference shareholders first, then to ordinary shareholders. Most preference shares are cumulative.