FINE 2000 Lecture Notes - Lecture 14: Private Placement, Eurodollar, Preferred Stock

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10 Jan 2017

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Authorized share capital maximum number of shares that a company is allowed to issue. Par value value of security shown on certificate. Additional paid-in capital difference between issue price and par value of stock, also called capital. Bv is backward-looking; it is based on how much capital the firm has raised from shareholders in. It does not measure the value that investors put on those shares today the past. The market value is forward-looking; it depends on the future dividends that shareholders expect to receive. Because dividends are discretionary, they are not considered an expense; which is why they are not allowed to deduct dividend payments from taxable income. What do we mean shareholders own the corporation: shareholders are entitled to whatever profits remain after paying off lenders, shareholders have control over decisions made by the company (some decisions require shareholder approval) Majority voting voting system in which each director is voted on separately.

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Question: How would you answer this students post with a paragraph or two with reference.

A company's net profits can be allocated to shareholders via a dividend, or kept within the company as retained earnings (Investopedia, n.d.). Since dividends are from net profits (or retained earnings) this helps explain why a company may issue or not issue dividends; meaning it depends on what the business intentions or strategic plan is (if they are in the build up or start up stage or want to invest in something large a company might not issue a dividend so they can invest that capital, or if they are larger company with a history of net income and retained earnings it may use a dividend as a means to reward their "owners" the stockholders). Also to consider a business does not have to issue dividends. It also may depend on how the board perceives growing income, either by stock price or thru dividends paid back when earnings are good. For example dividends "can" be taxed differently than other means of income meaning it may benefit the stockholders to receive that "income" thru dividends. Also to consider is, Economists Merton Miller and Franco Modigliani argued that a company's dividend policy is irrelevant, and it has no effect on the price of a firm's stock or its cost of capital (Investopedia, n.d.). Although not perfect, the theory states one can have the same effect either by dividend or use of the stocks to make the same effect, although this does not include items such as tax breaks, etc.

Adam Ketch

Reference:

Investopedia (n.d.) Dividend definition. Retrieved from http://www.investopedia.com/terms/d/dividend.asp

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Mutt.com was founded in 2006 by two graduates of the University of Wisconsin with the help from Georgina Sloberg, who had built up an enviable reputation for backing new start-up businesses. Mutt.com's user-friendly system was designed to find buyers for unwanted pets. Within 3 years the company was generating revenues of $3.4 million a year and, despite racking up sizeable losses, was regarded by investors as one of the hottest new e-commerce businesses. The news that the company was preparing to go public therefore generated considerable excitement. The company's entire equity capital of 1.5 million shares was owned by teo founders and Ms Sloberg. The intial public offering involved the sale of 500,000 shares by the three existing shareholders, together with the sale of further 750,000 shares by the company in order to provide funds for expansion. The company estimated that the issue would involve legal fees, auditing, printing, and other expenses of $1.3 million, which would be shared proportionately between selling shareholders and the company. In addition, the company agreed to pay the underwriters a spread of $1.25 per share (this cost would also be shared). The roadshow had confirmed the high level of interest in the issue, and indications from investors suggested that the entire issue could be sold at a price of $24 a share. The underwriters, however, cautioned about being too greedy on price. They pointed oot that indications from investors were not the same as firm orders. Also, they argued, it was much more important to have a successful issue than have a group of disgrunted shareholders. They therefore suggested an issue price of $18 a share. That evening Mutt.com's financial manager decided to run through some calculations. First, she worked out the net receipts to the company and the exsisting shareholders assuming the stock was sold at $18 per share. Next, she looked at the various costs of the IPO and tried to judge how they stacked up against the question of underpricing. When she had raised the matter with the underwritters that morning, they had dismissed the notion that the initial day's return on an IPO should be considered part of the issue costs. One of the members of the underwriting team asked: "the underwritiers want to see a high return and a high stock price. "Would Mutt.Com prefer a low stock price? Would that make the issue less costly?" Mutt.Com's financial manager was not convinced but felt that she should have a good answer. She wondered wheather unerpricing was only a problem because the exsisting shareholders were selling part of their holdings. Perhaps the issue price would not matter if they had not planned to sell.

Please answer the following questions after reading the attached MiniCase: 1. Calculate all flotation (issue) costs of IPO for Mutt.Com 2. Calculate the three ratios (Direct Cost Ratio: Direct Costs/Funds Raised) and (Indirect Cost Ratio: Underpricing Costs/Funds Raised). Compare these two ratios to the numbers in Figure 15.3 and Figure 15.5 in Chapter 15. 3. Calculate the spread cost ratio (Spread Cost Ratio: Total Spread Cost/Funds Raised). Compare this ratio to the numbers in Table 15.3 in Chapter 15. 4. Calculate another ratio known as total flotation cost ratio (Total flotation costs/Value of Shares issued). Please note that the value of shares issued is based on the non-underpriced value of the issue. Do you think that issuing equity is a cheap process? Use your answer to justify your opinion. 5. Answer the following questions in the MiniCase focusing on whether underpricing should be considered as a part of total flotation cost: a. Would Mutt.Com prefer a low stock price? b. Would that make the issue less costly?

ochresnake128

9. Which of the following statements is NOT CORRECT?

a	a. Owners of preferred stock have greater voting rights than common shareholders.
	b. From an individual investor's perspective, preferred stock is riskier than bonds.
	c. Companies are more likely to issue preferred stock if they have a low tax bracket since preferred stock dividends are not tax deductible.
	d. If a preferred issue is cumulative this means that any unpaid dividends are held in arrears.

10. As a general rule, the optimal capital structure

Maximizes expected EPS also maximizes the price per share of common stock.
Minimizes the interest rate on debt also maximizes the expected EPS.
Minimizes the required rate on equity also maximizes the stock price.
Maximizes the price per share of common stock and minimizes the WACC.

11. Which of the following statements about warrants and convertibles is NOT CORRECT?

a. The value of both warrants and convertibles depends on the stock price.

b. One primary difference between warrants and convertibles is that warrants bring in additional funds to the firm when exercised while convertibles reduce debt when exercised.

c. The coupon rate on convertible debt is higher than the coupon rate on similar straight debt because convertibles are riskier.

d. Warrants and Convertibles are used by corporations in order to get a lower rate on their debt.

12. In the lease versus buy decision, leasing is often preferable

a. if the firm is unable to borrow funds at a low rate.

b. if the firm needs a specific piece of equipment that only has value to that firm.

c. Because lease obligations do not affect the riskiness of the firm.

d. if the lessee has a higher tax rate than the lessor

13. Which statement is False?

The WACC is the required return on the firm

cerisejackal589

FINE 2000 Lecture Notes - Lecture 14: Private Placement, Eurodollar, Preferred Stock

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