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Chapter 7 Common stock: characteristics, valuation, and issuance
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Common Stock Common stock (C/S) is the permanent long-term financing of the firm Represents the true residual ownership of the firm
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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
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Rights of Common Stockholders Dividend rights Asset rights Preemptive rights Voting rights
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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
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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
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C/S Advantages and Disadvantages Advantages çFlexible çReduced financial leverage çLower cost of capital Disadvantages çDiluted EPS çExpensive
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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
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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
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Other Issuance Costs Management time Underpricing new equity Stock price declines Incentives “Green shoe” option
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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
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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
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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
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Zero Growth
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Constant Growth
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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
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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
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