Chapter 7 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  Contributed capital in excess of par äAdditional paid in capital äCapital surplus  Retained earnings ( R/E )  Book value / share = equity # of shares outstanding

Rights of Common Stockholders  Dividend rights  Asset rights  Preemptive rights  Voting rights

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

Features of C/S  C/S classes äVoting and nonvoting äSpecific ownership  Stock dividends äTransfer from R/E account to the C/S and additional paid- in capital accounts  Stock repurchases äDisposition of excess cash äFinancial restructuring äFuture corporate needs äReduction of takeover risk  Stock splits  Reverse stock splits

C/S Advantages and Disadvantages  Advantages çFlexible çReduced financial leverage çLower cost of capital  Disadvantages çDiluted EPS çExpensive

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

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

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

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

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

Dividend Valuation Models  Zero growth äG = 0  Constant growth dividend äK e > g äD t = D 0 ( 1 + g ) t  Above-normal growth äMultiple growth rates

Zero Growth

Constant Growth

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 p 0

Valuing Small Firms  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