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 companiesFinance expansionRapid growthOpening new market linesMergers and acquisitions
3 Introduction How can a firm raise money?? Equity: the value of an ownership interest in property or interest in a corporation in the form of common stock or preferred stocks2. 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 interestrequirements.
4 Capital for new firmsCan new start-up firms rely on bank loans for capital?Venture capital: general term for financing startup, early stage, and "turn around" type businessesSources of VCNew business will be riskyWhat does Venture capitalist do to avoid this risk?Why might Venture capitalist be willing to take this risk?
5 Capital for existing firms How can a company finance its investments?Selling securities to the publicPublicPrivateGeneral cash offerRights offerInitial public offering (IPO)Seasoned equity offering (SEO)Refer to table 15.1
6 UnderwritersDefinition: investment firms that act as intermediaries between a company selling securities and the investing capitalServices provided by underwritersFormulate method used to issue securitiesPrice the securitiesSell the securitiesPrice stabilization by lead underwriter
7 UnderwritersSyndicate – group of investment bankers that market the securities and share the risk associated with selling the issueSpread – difference between what the syndicate pays the company and what the security sells for initially in the market
8 Types of underwriter Firm Commitment Underwriting Issuer sells entire issue to underwriting syndicateThe syndicate then resells the issue to the publicThe underwriter makes money on the spread between the price paid to the issuer and the price received from investors when the stock is soldThe syndicate bears the risk of not being able to sell the entire issue for more than the cost
9 Types of underwriter Best efforts underwriting Underwriter must make their “best effort” to sell the securities at an agreed-upon offering priceThe company bears the risk of the issue not being soldNot as common as it used to be
10 Types of underwriter Dutch auction underwriting: Underwriter accepts a series of bids that include number of shares and price per shareGoogle was the first large Dutch auction IPO
11 IPOs & under pricing Initial Public Offering – IPO May be difficult to price an IPO because there isn’t a current market price availableUnder pricing causes the issuer to “leave money on the table”
12 Why does under pricing exist? To attract investors for young firmsTo act as an Insurance for the investment bankA 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 Gross spreadOther direct expensesIndirect expensesAbnormal returnsUnder pricing
14 RightsDefinition: an issue of common stock offered to existing stockholders“Rights” are given to the shareholdersSpecify number of shares that can be purchasedSpecify purchase priceSpecify time frameWhy do companies offer Rights? (Advantages)Rights may be traded OTC or on an exchange
15 Rights The mechanics of a rights offering Number of rights needed to purchase a share
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:Number of new shares to be issuedNumber of rights needed to buy a new shareThe value of the rightShow in calculations the effects of the rights offering on shareholders
17 Effects on share holders The case of buying a new share using rightsThe case of selling rights
18 The value of a right Results The price specified in a rights offering is generally less than the current market priceThe share price will adjust based on the number of new shares issuedThe value of the right is the difference between the old share price and the “new” share price
19 Rights Offering Example Suppose a company wants to raise $10 million. The subscription price is $20 and the current stock price is $25. The firm currently has 5,000,000 shares outstanding.How many shares have to be issued?How many rights will it take to purchase one share?What is the value of a right?
20 DilutionDilution is a loss in value for existing shareholders that occurs through the issuance of additional stocksDilution kinds:Percentage ownership – shares sold to the general public without a rights offeringMarket value – firm accepts negative NPV projectsBook value and EPS – occurs when market-to-book value is less than one
21 Issuing Long-term Debt Types of Long-term DebtPublic issue of long-term debt are usually in the form of bondsPrivate issuesLong-Term loans usually bank loans or could be from private firm which has a history with the companyEasier to renegotiate than public issuesIf bonds were issued to private investors costs would be lower than public issuesMORE THAN 50% OF ALL DEBT ARE ISSUED PRIVATELYInterest rates are higher in private issues when compared to public issues
22 Ex 1 Page 505Big Time, Inc., is proposing a rights offering. Presently there are 500,000 shares outstanding at 81$ each. There will be 60,000 new shares offered at 70$ each.What is the new market value of the firmHow many rights are associated with one of the new shares?What is the value of a right?Why might a company have a rights offering rather than a general cash offer?