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CHAPTER 15 Raising Capital. Introduction Definition of capital: borrowed sums or equity with which the firm's assets are acquired and its operations are.

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Presentation on theme: "CHAPTER 15 Raising Capital. Introduction Definition of capital: borrowed sums or equity with which the firm's assets are acquired and its operations are."— Presentation transcript:

1 CHAPTER 15 Raising Capital

2 Introduction Definition of capital: borrowed sums or equity with which the firm's assets are acquired and its operations are funded. When does a firm need capital? New or start up companies Finance expansion Rapid growth Opening new market lines Mergers and acquisitions

3 How can a firm raise money?? 1. Equity: the value of an ownership interest in property or interest in a corporation in the form of common stock or preferred stocks 2. Debt: An amount owed to a person or organization for funds borrowed. Debt can be represented by a loan note, bond, mortgage or other form stating repayment terms and interest requirements. Introduction

4 Can new start-up firms rely on bank loans for capital? Venture capital: general term for financing startup, early stage, and "turn around" type businesses Sources of VC New business will be risky What does Venture capitalist do to avoid this risk? Why might Venture capitalist be willing to take this risk? Capital for new firms

5 Capital for existing firms How can a company finance its investments? 1. Selling securities to the public A. Public B. Private 2. General cash offer 3. Rights offer 4. Initial public offering (IPO) 5. Seasoned equity offering (SEO) Refer to table 15.1

6 Underwriters Definition: investment firms that act as intermediaries between a company selling securities and the investing capital Services provided by underwriters  Formulate method used to issue securities  Price the securities  Sell the securities  Price stabilization by lead underwriter

7 Syndicate – group of investment bankers that market the securities and share the risk associated with selling the issue Spread – difference between what the syndicate pays the company and what the security sells for initially in the market Underwriters

8 Types of underwriter 1. Firm Commitment Underwriting Issuer sells entire issue to underwriting syndicate The syndicate then resells the issue to the public The underwriter makes money on the spread between the price paid to the issuer and the price received from investors when the stock is sold The syndicate bears the risk of not being able to sell the entire issue for more than the cost

9 2. Best efforts underwriting Underwriter must make their “best effort” to sell the securities at an agreed-upon offering price The company bears the risk of the issue not being sold Not as common as it used to be Types of underwriter

10 3. Dutch auction underwriting: Underwriter accepts a series of bids that include number of shares and price per share Google was the first large Dutch auction IPO Types of underwriter

11 IPOs & under pricing Initial Public Offering – IPO May be difficult to price an IPO because there isn’t a current market price available Under pricing causes the issuer to “leave money on the table”

12 Why does under pricing exist? To attract investors for young firms To act as an Insurance for the investment bank A way that a bank can reward investors for reveling what they think the stock worth and the numbers of shares they would like to buy

13 The costs of issuing securities 1. Gross spread 2. Other direct expenses 3. Indirect expenses 4. Abnormal returns 5. Under pricing

14 Rights Definition: an issue of common stock offered to existing stockholders “Rights” are given to the shareholders  Specify number of shares that can be purchased  Specify purchase price  Specify time frame Why do companies offer Rights? (Advantages) Rights may be traded OTC or on an exchange

15 The mechanics of a rights offering Number of rights needed to purchase a share Rights

16 The value of a right Example: National Power current share price is 20$, there is 1,000,000 shares outstanding. Suppose they want to raise 5,000,000$ in new equity using a right offering (1 right for each 1 share) with a subscription price of 10$. Calculate the following: 1. Number of new shares to be issued 2. Number of rights needed to buy a new share 3. The value of the right 4. Show in calculations the effects of the rights offering on shareholders

17 Effects on share holders The case of buying a new share using rights The case of selling rights

18 Results The price specified in a rights offering is generally less than the current market price The share price will adjust based on the number of new shares issued The value of the right is the difference between the old share price and the “new” share price The value of a right

19 Suppose a company wants to raise $10 million. The subscription price is $20 and the current stock price is $25. The firm currently has 5,000,000 shares outstanding.  How many shares have to be issued?  How many rights will it take to purchase one share?  What is the value of a right? Rights Offering Example

20 Dilution Dilution is a loss in value for existing shareholders that occurs through the issuance of additional stocks Dilution kinds: 1. Percentage ownership – shares sold to the general public without a rights offering 2. Market value – firm accepts negative NPV projects 3. Book value and EPS – occurs when market-to-book value is less than one

21 Types of Long-term Debt 1. Public issue of long-term debt are usually in the form of bonds 2. Private issues  Long-Term loans usually bank loans or could be from private firm which has a history with the company  Easier to renegotiate than public issues  If bonds were issued to private investors costs would be lower than public issues  MORE THAN 50% OF ALL DEBT ARE ISSUED PRIVATELY  Interest rates are higher in private issues when compared to public issues Issuing Long-term Debt

22 Ex 1 Page 505 Big Time, Inc., is proposing a rights offering. Presently there are 500,000 shares outstanding at 81$ each. There will be 60,000 new shares offered at 70$ each. A. What is the new market value of the firm B. How many rights are associated with one of the new shares? C. What is the value of a right? D. Why might a company have a rights offering rather than a general cash offer?

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