The art and Science of managing money concerned with the process, institution, markets, and instrument involved in the transfer of money among and between individuals, businesses, and governments Corporate Finance

Common Stock Chapter # 1

Common Stock Stocks are a type of security that signifies ownership in a corporation and represents a claim on part of the corporation's assets and earnings.

Specimen

Types Common Stock: usually entitles the owner to vote at shareholders' meetings and to receive dividends Preferred Stock : generally does not have voting rights, but has a higher claim on assets and earnings than the common shares

Difference between Debts and Equity Debts: debts holders don’t have voting right. Equity: Equity holders have voting right. Debts: Claims on income and assets are senior to equity. Equity: Claims on income and assets are subordinate to debt. Debts: Maturity is known. Equity: don’t have the maturity date.

Common Stock and its features Common Stock holders are the pure owners of the business. Some time they referred to residual owners because they receive what is left. Ownership: Privately Owned Stock: All common stock of a firm owned by single individual. Closely Owned Stock: All common stock of a firm owned by small group of investor. Publicly Owned Stock: All common stock of a firm owned by a broad group of individuals.

Conti…. Par Value: the value that is mention on the face of the share. Preemptive Right: the preemptive right allows common stockholders to maintain their balanced ownership in the corporation when new shares are issued. It allows existing shareholders to maintain the voting control.

Conti… Authorized, outstanding and issued shares: The maximum amount of shares that a company can issue. It is called Authorized Shares. The shares held by the public is called outstanding shares. If the firm repurchase any of its outstanding shares, these shares are as treasury stock and are not considered to be outstanding shares. Issued Shares: The share of the common stock that have been put into circulation; they represent the sum of outstanding shares and treasury stock.

Conti….. Voting Right: the common stockholder have voting power, they elect board of directors. Most small stockholders do not attend the annual meeting, they may sign a “Proxy Statement” transferring their votes to an other party. Dividends: the amount that is paid to stockholders are called dividends. Before the dividends are paid to common stockholders, the claims of the government, all creditors and preferred stockholders must be satisfied.

Preferred Stock and its features Preferred stock give its holder certain privileges that make them senior to common stockholders. Preferred stockholder are promised a fixed periodic dividends, which is stated either as a %age or as a dollar amount. 1) The preferred stock are considered Quasi-debt. It has partly characteristic of debts and partly characteristic of equity. 2) Preference over common stock. 3) Don’t have voting power. 4) Preferred stock is cumulative w.r.to any dividends passed.

Single-period valuation Model: The investor expects to hold the equity share for one year: the price of equity share will be: P 0 = D 1 / (1+r) + P 1 / (1+r)

Conti….. Where P 0 = Current price of the equity share D 1 = Expected dividend after one year P 1 = Expected price after one year r = Required rate of return

Example: hp equity share is expected to provide a dividend of $ 2 and fetch a price of $ 18 after one year. What price would it sell for now if the investor required rate of return is 12%. P 0 = D 1 / (1+r) + P 1 / (1+r) P 0 = 2 / (1.12) + 18 / (1.12) P 0 = 17.86

Expected rate of return It can be calculated with the help of the following formula: r = (D 1 / P 0 )+g Where r = required rate of return D 1 = Dividend per share P 0 = price per share g = growth rate

Example: The expected dividend per share of hp is $ 5. the dividend is expected to grow at the rate of 6% per year. If the per share now is 50, What is the expected rate of return? r = (D 1 / P 0 ) + g r = (5 / 50 ) = = 0.16 r = 16 %