1. Copyright ©2003 South-Western/Thomson Learning Chapter 7 Common Stock: Characteristics, Valuation, and Issuance

2. Introduction This chapter describes the characteristics of common stock. It discusses the process for selling securities and the role of the investment banker. It develops the valuation models for common stock.

3. Common Stock Common stock (C/S) is the permanent long-term financing of a firm. Represents the true residual ownership of a firm Stockholders elect the board of directors.

4. 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 per share equity # shares outstanding =

5. Rights of Common Stockholders Dividend rights Asset rights Preemptive rights Voting rights

6. Voting for the Board of Directors Majority voting requires more than 50 percent 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

7. Features of C/S 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

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

9. 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

10. How Are Securities Sold? Public cash offering –Selling securities through investment bankers to the public –IPO’s Web site: http://www.ipo.com/http://www.ipo.com/ 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.

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

12. Registration Requirements SEC act of 1933 & SEC exchange act of 1934 Any interstate security issue over $1.5 million and having a maturity greater than 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 Check NYSE regulations http://www.nyse.com/about/about.html

13. Global Equity Markets Multinational firms can take advantage of institutional differences from one country to another. Stock markets in United States, Japan, London, and Paris Nearly 24-hour per day trading of C/S Provide investors with opportunities to buy and sell shares any time they wish Global name and product recognition

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

15. Dividend Valuation Models Zero growth –g = 0 Constant growth dividend –k e > g –D t = D 0 (1 + g) t Above-normal growth –Multiple growth rates

16. Zero Growth

17. Constant Growth

18. 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

19. Common Stock Valuation: Nonconstant Dividends (1) Example on pages 260-261, MMK 9ed Calculate forecasts of annual dividends as shown on page 261 using D t =D 0 (1+g) t Calculate the value of the stock at five years from the present time

20. Common Stock Valuation: Nonconstant Dividends (2) Find the price by finding the PV of all expected cash flows. Using tables:

21. Common Stock Valuation: Nonconstant Dividends (3) Calculator: TI BA II Plus Delete previous inputs: CE/C, 2 nd, CLR TVM, CF, 2 nd, CLR WORK Inputs for finding stock price: (Display) 0.0000 CFCF0= 0.0000 ENTERCF0= 0.0000 C01 0.0000 2.24C01 2.24 ENTERC01= 2.2400

22. Common Stock Valuation: Nonconstant Dividends (4) (Display) 2.2400 F01= 1.0000 C02= 0.0000 2.51C02 2.51 ENTERC02= 2.5100 F02= 1.0000 C03 0.0000 2.81C03 2.81 ENTERC03= 2.8100

23. Common Stock Valuation: Nonconstant Dividends (5) (Display) 2.8100 F03= 1.0000 C04= 0.0000 3.15C04 3.15 ENTERC04= 3.1500 F04= 1.0000 C05 0.0000 45.09C05 45.09 ENTERC05= 45.0900

24. Common Stock Valuation: Nonconstant Dividends (6) (Display) 45.0900 NPVI = 0.0000 15I 15 ENTERI = 15.0000 NPV= 0.0000 CPTNPV= 29.9121

25. Sources of Analyst Growth Rate Forecasts Value Line Investment Survey –http://www.valueline.com/http://www.valueline.com/ Institutional Brokers Estimate System –http://www.ibes.com/http://www.ibes.com/ Zacks Earnings Estimates –http://www.zacks.com/http://www.zacks.com/

26. 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 Valuation Web site: http://www.bearval.com/http://www.bearval.com/