FINS1613 Lecture Notes - Lecture 3: Common Stock, Dividend, Capital Structure
Wednesday, 15 March 2017
Business Finance
Valuation of a Firms’ Securities
-Corporations:
•Own legal entity, distinct from owners
•Separation between ownership & management
-Capital Structure:
•Firms’ source of financing is called its capital; capital structure is the ownership
structure of a firm - consists of debt, equity & other securities outstanding
•Focus on market value of securities - price investors willing to pay for cash flows &
legal rights promised by securities
-Differs from face value of securities (notional “value” to determine cash flows) &
book value (accounting figure)
-Securities: (e.g. debt & equity)
•Financial instruments that gives investors rights to cash flows from a firm
•Vary in terms of cash flows, rights of investors to enforce payment & ability of
investors to influence firm decision making
-Bond:
•A security sold by governments & corporations to raise money from investors today
in exchange for promised future payments - form of debt financing
-Terms indicate amount & date of all payments - firm obligated to make payments
to bond holders
-Failure to do so triggers administration (Aus, U.K.) or bankruptcy (US)
-Preference Shares:
•Security sold by corporations to raise money from investors today in exchange for
expected future payments
•Holder receives dividend payments & paid ‘in preference’ to ordinary shares
-Not guaranteed - firm not obligated to make payments
-Also known as preferred stock & are a form of equity financing
-Ordinary Shares:
!1
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Wednesday, 15 March 2017
•Security sold by corporations to raise money from investors today in exchange for
expected future payments
•Holders received dividend payments - determined by board of directors
•Also known as common stock - form of equity financing
-Administration (Bankruptcy):
•When a firm cannot make a promised payment to bond holders - may enter
bankruptcy
•Payments ordered by absolute priority (seniority dictates order of payment with
available capital)
-Bond holders paid first, then preference shares then ordinary equity shares
•Payments in liquidation may be subject to secured collateral
-Bonds may be secured by specific assets of firm; bond collateralised by
manufacturing plant receives preference for cash received when plant is sold
-Residual Claim:
•Ordinary share equity is residual claim in firm’s capital structure, receiving cash
flows only after payments are made to all other securities
•If firm does poorly, payments to residual claimant are stopped
•If firm does well, residual claimant receives all excess cash flows
•Of all security types, ordinary shares benefit most when firm does well & lose most
when firm does poorly
!2
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Wednesday, 15 March 2017
-Capital Structure:
•Market value of each security in capital structure determined by investors who
examine:
-Expected cash flows by firm to security holder
-Cash flow guarantees & control rights granted by security
•Firms’ new projects may be financed through:
-Existing cash
-Security issuance (sale of new securities to investors)
•Financing activities ensure capital structure of firm is constantly changing
-Issuance:
•Investment bankers may serve as underwriters:
-Provide advice to firm in exchange for fee
-Manage security issuance & design security structure
-Markets & sells security
-May promise to purchase any unsold securities
•Debt Issuance:
-Private debt: Debt not traded consisting of bank loans & private placements (debt
sold to small group of investors)
-Public debt: Bonds publicly traded
•Equity Issuance has two forms:
-IPO: First public sale of equity from a privately held firm
-Seasoned Equity Offering (SEO): Sale of new equity from a publicly held firm
•May consist of new shares to raise capital or existing shares from large
shareholders looking to reduce investment
-Enterprise Value:
•Value of firm’s underlying business
-Total firm value comprises enterprise value & cash (or similar assets)
-Must be equal to total market value of firm’s equity & debt
-Enterprise Value + Cash = Market value of debt + Market value of equity
!3
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Document Summary
Corporations: own legal entity, distinct from owners, separation between ownership & management. Differs from face value of securities (notional value to determine cash ows) & book value (accounting gure) Bond: a security sold by governments & corporations to raise money from investors today in exchange for promised future payments - form of debt nancing. Terms indicate amount & date of all payments - rm obligated to make payments to bond holders. Failure to do so triggers administration (aus, u. k. ) or bankruptcy (us) Preference shares: security sold by corporations to raise money from investors today in exchange for expected future payments, holder receives dividend payments & paid in preference" to ordinary shares. Not guaranteed - rm not obligated to make payments. Also known as preferred stock & are a form of equity nancing. !1: security sold by corporations to raise money from investors today in exchange for expected future payments, holders received dividend payments - determined by board of directors.
