© 2001 South-Western College Publishing Chapter 7 Common stock: characteristics, valuation, and issuance

2 Common Stock u Common stock (C/S) is the permanent long- term financing of the firm u Represents the true residual ownership of the firm

3 Balance Sheet Accounts Associated With C/S u Par value of C/S u Contributed capital in excess of par ä Additional paid in capital ä Capital surplus u Retained earnings ( R/E ) u Book value per share = equity # of shares outstanding

4 Rights of Common Stockholders u Dividend rights u Asset rights u Preemptive rights u Voting rights

5 Voting for the Board of Directors u Majority voting requires more than 50% of the votes to elect a director u Cumulative voting u Shareholders may concentrate votes on a few candidates u Proxy - signing over your voting rights to someone else

6 Features of C/S u C/S classes ä Voting and nonvoting ä Specific ownership u Stock dividends ä Transfer from R/E account to the C/S and additional paid-in capital accounts u Stock repurchases ä Disposition of excess cash ä Financial restructuring ä Future corporate needs ä Reduction of takeover risk u Stock splits u Reverse stock splits

7 C/S Advantages and Disadvantages u Advantages ç Flexible ç Reduced financial leverage ç Lower cost of capital u Disadvantages ç Diluted EPS ç Expensive

8 Investment Banking u Long-range financial planning u Timing of security issues u Purchase of securities u Marketing of securities u Arrangement of private loans and leases u Negotiation of mergers

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

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

11 Registration Requirements u Sec act of 1933 & sec exchange act of 1934 u Any interstate security issue over $1.5 million and having a maturity > 270 days is required to register issue with the SEC u Provide all buyers of the new security with a final copy of the prospectus u Shelf registration

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

13 Valuation of C/S u 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

14 Dividend Valuation Models u Zero growth ä G = 0 u Constant growth dividend ä K e > g ä D t = D 0 ( 1 + g ) t u Above-normal growth ä Multiple growth rates

15 Zero Growth

16 Constant Growth

17 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

18 Valuing Small Firms u Nature of business u History of business u Economic outlook u Dividend paying capacity u Industry u Earnings capacity u Book value u Financial condition u Majority or minority interest u Voting or nonvoting