Tài chính doanh nghiệp - Chapter 5: Corporations issuing equity in the share market

Chapter 5CorporationsIssuing Equity in theShare MarketWebsite:  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonLearning ObjectivesExamine issues relevant to the choice between debt and equity fundingOutline ASX floatation and listing rulesDescribe the equity-funding alternatives available to newly listed and established corporationsDistinguish between equity and quasi-equity securitiesCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonChapter Organisation5.1 Introduction5.2 The Investment Decision5.3 The Financing Decision5.4 Initial Public Offering (IPO)5.5 Listing a Business on the Stock Exchange5.6 Equity-funding Alternatives for Listed Companies5.7 SummaryCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson5.1 IntroductionThe objective of financial management is to maximise shareholder valueThere are four main aspects of financial managementInvestment decision (capital budgeting)In which assets to invest?Financing decision (capital structure)How to fund the purchase of these assets?Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson5.1 Introduction (cont.)Liquidity (working capital) managementHow to best manage current assets and current liabilities?Dividend policy decisionHow to retain and/or distribute profits?This chapter focuses on the financing (funding) decisionCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonChapter Organisation5.1 Introduction5.2 The Investment Decision5.3 The Financing Decision5.4 Initial Public Offering (IPO)5.5 Listing a Business on the Stock Exchange5.6 Equity-funding Alternatives for Listed Companies5.7 SummaryCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson5.2 The Investment DecisionA corporation first determines the assets in which it will invest funds according to organisational objectivesReal assets e.g. plant and equipmentFinancial assets e.g. equities, bondsCompeting investment alternatives should be evaluated on the basis of shareholder wealth maximisationCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson5.2 The Investment Decision (cont.)Two important measures used to quantify the contribution of an investment to shareholder wealth areNet present value (NPV)Internal rate of return (IRR)Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson5.2 The Investment Decision (cont.)NPVThe difference between the present value of cash flows associated with an investment, and the cost of the investmentThe NPV decision ruleAccept an investment that has a positive NPV i.e. reject an investment with a negative NPVCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson5.2 The Investment Decision (cont.)NPV (and IRR) are influenced byThe accuracy of the forecasted cash flowsThe discount rate (required rate of return)Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson5.2 The Investment Decision (cont.)IRRThe required rate of return that results in a NPV of zeroThe IRR acceptance ruleAccept the investment if its IRR is greater that the firm’s required rate of returnCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson5.2 The Investment Decision (cont.)Limitations of IRRNon-conventional cash flowsCan result in multiple IRRsMutually exclusive projectsA situation where, from a choice of two or more projects, only one project can be chosenCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonChapter Organisation5.1 Introduction5.2 The Investment Decision5.3 The Financing Decision5.4 Initial Public Offering (IPO)5.5 Listing a Business on the Stock Exchange5.6 Equity-funding Alternatives for Listed Companies5.7 SummaryCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson5.3 The Financing DecisionThe financing decision concerns the capital structure used to fund the firm’s business activitiesThe financial objective of a corporation is to maximise return, subject to an acceptable level of riskCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson5.3 The Financing Decision (cont.)Returns are generated from the net cash flows of the businessRisk is the uncertainty or variability of expected cash flows, caused by eitherBusiness riskFinancial riskCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson5.3 The Financing Decision (cont.)Business riskThe level of business risk depends upon the type of operations of the business i.e.Industry sector which influences the level of fixed versus variable operating costsAlso affected bySectoral growth ratesMarket shareAggressiveness of competitorsCompetence of management and workforceCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson5.3 The Financing Decision (cont.)Financial riskThe exposure to factors that impact the value of assets, liabilities and cash flowsThe level of financial risk of a company is borne by the security holders (debt and equity)Financial risk categoriesInterest rate riskRisk of adverse movements in interest ratesCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson5.3 The Financing Decision (cont.)Financial risk categories (cont.)Foreign exchange riskRisk of adverse movements in exchange ratesLiquidity riskRisk of insufficient cash in the short termCredit riskRisk of default or untimely payments by debtorsCapital riskRisk of insufficient shareholder funds to meet capital growth needs or absorb abnormal lossesCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson5.3 The Financing Decision (cont.)Financial risk categories (cont.)Country riskRisk of financial loss due to currency devaluation or inconvertibilityDebt to equity ratio (D/E) i.e. the ratio of funds contributed by shareholders (equity) to funds borrowed (debt)Risk of being unable to meet interest due and principal repayments associated with use of debt i.e. risk of insolvencyCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson5.3 The Financing Decision (cont.)Earnings per share (EPS) is the net return on a company’s shares expressed in cents per shareIf the cost of debt is less than the return achieved, then issuing more debt will benefit shareholders due to higher EPSHowever, high debt levels increase the company’s level of financial risk and, thus, the risk of insolvencyCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson5.3 The Financing Decision (cont.)Is there an optimal debt to equity ratio?No optimal debt to equity ratioOptimal D/E for a company depends on Industry normsHistoric levels of a firm’s ratioLimits imposed through loan covenantsFirm’s capacity to service debtCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonChapter Organisation5.1 Introduction5.2 The Investment Decision5.3 The Financing Decision5.4 Initial Public Offering (IPO)5.5 Listing a Business on the Stock Exchange5.6 Equity-funding Alternatives for Listed Companies5.7 SummaryCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson5.4 Initial Public Offering (IPO)IPO is an offer to investors of ordinary shares in a newly listed company on a stock exchangeNew share issuer must meet ASX listing requirementsThe promoter appoints advisors (stockbroker, merchant bank, other specialists) and possibly underwritersCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson5.4 Initial Public Offering (IPO) (cont.)UnderwritersEnsure companies raise full amount of the issueAssist with advice on the structure, price, timing and marketing of the issue and allocation of securitiesProspectus lodged with ASICCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson5.4 Initial Public Offering (IPO) (cont.)Ordinary shares: limited liability companiesMajor source of equity fundingShareholders have voting rights at general meetingsShareholders may transfer voting rights to a proxyCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson5.4 Initial Public Offering (IPO) (cont.)Shares usually sold fully paid, or can be partly paid or by instalment receiptShareholder’s liability is limited to the extent of the fully paid sharesPartly paid shareholders have a contractual obligation to pay the remaining amount (the call) to the companyCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson5.4 Initial Public Offering (IPO) (cont.)Ordinary shares: no liability companiesUsed for highly speculative venturesShares issued as partly paidShareholders may decide not to meet future calls, in which case they forfeit the partly paid sharesCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonChapter Organisation5.1 Introduction5.2 The Investment Decision5.3 The Financing Decision5.4 Initial Public Offering (IPO)5.5 Listing a Business on the Stock Exchange5.6 Equity-funding Alternatives for Listed Companies5.7 SummaryCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson5.5 Listing a Business on the Stock ExchangeListing rule principlesAdmission to a stock exchangeQuotation of securitiesCost of listingContinuing listing requirementsCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonListing rule principlesA company seeking to have its securities quoted on a stock exchange (i.e. join the official list) must comply with listing rules which are additional to the corporations legislation obligationsListing rule principles have been established to maintain market integrity and protect investorsCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonListing rule principles (cont.)Listing rule principles are specific criteria that must be met and includeMinimum standards on quality, size, operations and disclosureSufficient investor interest required to warrant listingNew issues permitted if equitableCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonListing rule principles (cont.)Listing rule principles are specific criteria that must be met and include (cont.)Disclosure of relevant information of a sufficiently high standard to investorsRules on the behaviour of company officersCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonAdmission to a stock exchangeCompanies admitted to the ASX official list are characterised as eitherGeneralDebt issuerExempt foreign entityCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonAdmission to a stock exchange (cont.)General admission requirements includeSatisfying either profit test or assets test requirementsCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonQuotation of securitiesA general admission entity seeking quotation of its main class of securities on the official list must satisfy conditions includingCompliance with listing rulesQuoted securities must have an issue price of at least 20 centsCalls to be made by the entity must be set outCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonCosts of listingSignificant costs are involved with listing includingUnderwriting feesFloat management feesLegal feesAccounting and taxation feesASX listing fees and annual feesCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonContinuing listing requirementsListed companies must satisfy continuous disclosure requirements by notifying the ASX of any information expected to have a material effect on the share priceCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonContinuing listing requirements (cont.)Additionally, routine disclosure requirements include the provision ofHalf-yearly reports to the ASXYearly reports to both shareholders and the ASXCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonChapter Organisation5.1 Introduction5.2 The Investment Decision5.3 The Financing Decision5.4 Initial Public Offering (IPO)5.5 Listing a Business on the Stock Exchange5.6 Equity-funding Alternatives for Listed Companies5.7 SummaryCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson5.6 Equity-funding Alternatives for Listed CompaniesDifferent forms of equity finance are available to established companiesAdditional ordinary sharesRights issue, placements, takeover issues, dividend reinvestment schemesPreference sharesQuasi-equityConvertible notes, options, warrantsCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson5.6 Equity-funding Alternatives for Listed Companies (cont.)Rights issueIssue of ordinary shares to existing shareholdersIssued pro-rata (e.g. 1:5—1 for 5)Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson5.6 Equity-funding Alternatives for Listed Companies (cont.)Rights issue (cont.)Two typesRenounceable—shareholder may sell their rightNon-renounceable—right may not be soldRights issue made at a discount to current share priceCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson5.6 Equity-funding Alternatives for Listed Companies (cont.)PlacementsAdditional new ordinary shares issued to selected investors (typically institutions)Not required to register a prospectusMinimum subscription $500,000 to not more than 20 participantsCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson5.6 Equity-funding Alternatives for Listed Companies (cont.)Placements (cont.)Market price discount cannot be excessiveAllows smaller discount and shorter time frame than rights issueDilutes holding of non-participating shareholdersCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson5.6 Equity-funding Alternatives for Listed Companies (cont.)Takeover issuesThe acquiring company issues additional ordinary shares to the owners of the target company in settlement of the transactionAlleviates the need for owners of the acquiring company to inject further equity for the purchase of the companyCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson5.6 Equity-funding Alternatives for Listed Companies (cont.)Dividend reinvestment schemesShareholders have the option of reinvesting dividends in additional ordinary sharesGenerally issued at a discountNo brokerage or stamp duty payableCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson5.6 Equity-funding Alternatives for Listed Companies (cont.)Dividend reinvestment schemes (cont.)In growth periods it allows companies to pay dividends and pass on tax credits, while increasing equitySchemes may be suspended in low growth periodsCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson5.6 Equity-funding Alternatives for Listed Companies (cont.)Preference sharesAre hybrid securities (i.e. they have characteristics of both debt and equity)Fixed dividend rates are set at issue dateRank ahead of ordinary shareholders in the payment of dividends and liquidationCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson5.6 Equity-funding Alternatives for Listed Companies (cont.)Preference shares (cont.)Include combinations of the following featuresCumulative or non-cumulativeRedeemable or non-redeemableConvertible or non-convertibleParticipating or non-participatingIssued with different rankingsCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson5.6 Equity-funding Alternatives for Listed Companies (cont.)Preference shares (cont.)Advantages of preference sharesIn effect preference shares are fixed interest borrowings, but are an equity finance instrumentAssists in maintaining debt to equity ratioWidens a company’s equity base, which allows further debt to also be raisedCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson5.6 Equity-funding Alternatives for Listed Companies (cont.)Preference shares (cont.)Advantages of preference shares (cont.)Dividends may be deferred on cumulative shares, and not paid on non-cumulative shares, while interest on debt must be paidCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson5.6 Equity-funding Alternatives for Listed Companies (cont.)Convertible notesAre a hybrid instrument—initially as a debt instrument issued for a fixed termInterest payments are specified in the noteBestows the right to convert the note into ordinary shares at a specified future date at a predetermined priceCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson5.6 Equity-funding Alternatives for Listed Companies (cont.)Convertible notes (cont.)The option to convert to equity has valueThe conversion price is nominated at note issue—a gain is made if share price rises subsequentlyIf share price falls, holder may not exercise conversion option, and take the notes cash valueCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson5.6 Equity-funding Alternatives for Listed Companies (cont.)Convertible notes (cont.)Interest paid on notes is usually lower than straight debt interestInterest payments are tax deductible to the companyNotes are often issued for longer periods than is possible with straight debt borrowingsCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson5.6 Equity-funding Alternatives for Listed Companies (cont.)Company-issued optionsProvide the right but not the obligation to purchase shares, at a stated price and dateIssued for a period of up to 5 yearsAllows companies to raise further equity funds at planned future dates (providing holders exercise the option)Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson5.6 Equity-funding Alternatives for Listed Companies (cont.)Company-issued options (cont.)Generally have value and may be tradedThe option will be exercised if the exercise price is less than the market price of the share at the exercise dateCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson5.6 Equity-funding Alternatives for Listed Companies (cont.)Company-issued equity warrantsGenerally attach to corporate bond issues; however, may be issued unattachedHolder has the option to convert the warrant into ordinary shares at a specified price over a given periodCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson5.6 Equity-funding Alternatives for Listed Companies (cont.)Company-issued equity warrants (cont.)Warrants may be detachable from the bond and traded separatelyHolder does not receive dividends, but may benefit from capital gains if the share price rises above the conversion priceCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonChapter Organisation5.1 Introduction5.2 The Investment Decision5.3 The Financing Decision5.4 Initial Public Offering (IPO)5.5 Listing a Business on the Stock Exchange5.6 Equity-funding Alternatives for Listed Companies5.7 SummaryCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson5.7 SummaryObjective of financial management is to maximise shareholder valueFour key financial management decisions involve investment, financing, liquidity (working capital) and dividendAppropriate investment decision techniques are NPV and IRRCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson5.7 Summary (cont.)The financing decision concerns the choice of capital structure (D/E) and influences a firm’s financial riskAdmission to the ASX broadens financing opportunities for firm, and is achievable by satisfying listing requirementsAdditional equity can be raised through ordinary shares, preference shares, convertible notes and other quasi-equityCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson