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Chapter 8

Chapter 8. Common stock: characteristics, valuation, and issuance. Common Stock. Common stock (C/S) is the permanent long-term financing of the firm Represents the true residual ownership of the firm. Balance Sheet Accounts Associated With C/S. Par value of C/S

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Chapter 8

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  1. Chapter 8 Common stock: characteristics, valuation, and issuance

  2. Common Stock • Common stock (C/S) is the permanent long-term financing of the firm • Represents the true residual ownership of the firm

  3. Balance Sheet Accounts Associated With C/S • Par value of C/S • Contributed capital in excess of par • Additional paid in capital • Capital surplus • Retained earnings ( R/E ) • Book value / share = equity # of shares outstanding

  4. Rights of Common Stockholders • Dividend rights • Asset rights • Preemptive rights • Voting rights

  5. Voting for the Board of Directors • Majority voting requires more than 50% of the votes to elect a director • Cumulative voting • Shareholders may concentrate votes on a few candidates • Proxy - signing over your voting rights to someone else

  6. C/S classes Voting and nonvoting Specific ownership Stock dividends Transfer from R/E account to the C/S and additional paid-in capital accounts Stock repurchases Disposition of excess cash Financial restructuring Future corporate needs Reduction of takeover risk Stock splits Reverse stock splits Features of C/S

  7. C/S Advantages and Disadvantages • Advantages • Flexible • Reduced financial leverage • Lower cost of capital • Disadvantages • Diluted EPS • Expensive

  8. Investment Banking • Long-range financial planning • Timing of security issues • Purchase of securities • Marketing of securities • Arrangement of private loans and leases • Negotiation of mergers

  9. How Are Securities Sold? • Public cash offering • Selling securities through investment bankers to the public • Private or direct placement • Placing a security issue with one or more large investors • Rights offering • Selling C/S to existing stockholders • Standby underwriting • Investment banker purchases shares not sold to rights holder

  10. Other Issuance Costs • Management time • Underpricing new equity • Stock price declines • Incentives • “Green shoe” option

  11. Registration Requirements • Sec act of 1933 & sec exchange act of 1934 • Any interstate security issue over $1.5 million and having a maturity > 270 days is required to register issue with the SEC • Provide all buyers of the new security with a final copy of the prospectus • Shelf registration

  12. Dividends • Not constant • Expected to grow over time • Capital gain or loss uncertain Valuation of C/S • Capitalized value of the stock’s expected stream of cash flow during holding period

  13. Dividend Valuation Models • Zero growth • G = 0 • Constant growth dividend • Ke > g • Dt = D0 ( 1 + g )t • Above-normal growth • Multiple growth rates

  14. Zero Growth

  15. Constant Growth

  16. Above Normal Growth 1. Find the PV of the dividends during the above-normal growth period ( if two or more above -normal growth periods continue with the PV of the second) 2a. Find the value of the C/S at the end of the above-normal growth period 2b. Discount the answer in 2a to the present time 3. Sum steps 1 and 2b to find p0

  17. Nature of business History of business Economic outlook Dividend paying capacity Industry Earnings capacity Book value Financial condition Majority or minority interest Voting or nonvoting Valuing Small Firms

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