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Financial management - equity share. Its a power point presentation to explain the basic of financial equity
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Long- Term Sources of Finance
Learning Objectives
Understand the features of ordinary/equity shares
Evaluate ordinary shares as A long term source of finance
Focus on right sharesLearn about preference sharesStudy the features and benefits of debt
financingExplore term loan as long term source of
financing
Topics Covered
Equity Shares/Ordinary SharesPreference ShareDebentures (Bonds)Term loan
Equity Shares or Ordinary Shares
Equity mean “Equality” among shareholdersOrdinary shares represent the ownership position
in a companyShareholders are the legal owners of the companyEquity shareholders provide permanent source of
capital or “Sine Die”It is also known as variable income securityEquity shareholders have the maximum risk
“Equity shareholders are the first to contribute to the capital and the last to receive any return”
Features of Ordinary shares
Claim on incomeClaim on assetsRight to controlVoting rightPre-emptive rightLimited liabilityNegotiable
Advantages of Ordinary Shares from Company’s view point
Permanent CapitalDividend payment discretionBorrowing base
Advantages from the shareholder’s view pointHigher returnVoting rightRight to controlLimited liability
Disadvantages of Ordinary shares from company’s view point
High cost:-Dividends are not tax deductibleHigher floatation costHigher expected return
Disadvantages from the shareholder’s view point
Earning dilutionOwnership dilutionNo fixed returnHigh Risk
Preference Shares: Hybrid Security
Commonalities between Ordinary Share & Preference Share:-
Dividends are non tax deductibleNon payment of dividend does not leads to
insolvencyIrredeemable preference shares have no
fixed date of maturity
Preference Shares: Hybrid Security
Commonalities between Debenture & Preference Share :-
Rate of Dividend is fixedPriority claim on income and assets over
ordinary shareholdersNo voting rightUsually do not share residual earnings
Preference Shares: Features
Preference over equity shareholders:- In dividend payment In asset realization (during liquidation)
Preference dividend is not tax deductibleFixed rate of dividendNo voting rights (exceptions are there)Claim on income and assetsPermanent/Temporary source of capitalHybrid Security
Voting Right of Preference Shares
Preference shareholders may be entitled to contingent or conditional voting right:-
They have a right to vote only on resolutions that directly affect the rights attached to preference shares e.g. Winding up, repayment or reduction of share capital
There are arrears in dividend for two or more years in case of cumulative preference shares;
Preference dividend is due for a period of two or more consecutive preceding years; or
In the preceding six years including the immediately preceding financial year, the company has not paid the preference dividend for a period of three or more years
In all the above situations the preference shareholders can nominate a member on the board of the company.
Types of Preference Shares
Cumulative and Non-Cumulative preference share
Redeemable and Irredeemable/Perpetual preference share
Convertible and Non-Convertible preference share
Participating and Non-Participating preference share
Advantages of Preference Share from Company’s view point
Limited Voting RightLimited amount of dividendDividend PostponabilityNon payment of dividend does not result in
insolvencyLess Costly
Disadvantages of Preference Share from Company’s view point
Non Tax deductibility of dividendLimited dividend Postponability
Right Issue
A right issues involves selling securities in the primary market by issuing rights to the existing shareholder. When a company issues additional equity capital, it has to be offered in the first instance to the existing shareholders on a pro rata basis. This is required under section 81 of the companies Act, 1956.
The shareholder, however, may by a special resolution forfeit this right, partially or fully, to enable the company to issue additional capital to public.
Features of Rights
The number of rights that a shareholders gets is dependent on the number of shares held by him
The number of right acquired to subscribe to an additional share is determined by the issuing company.
The price per share for additional equity, called the subscription price, is left to the discretion of the company
Rights are negotiable. The holder of the right can sell them
Rights can be exercised only during a fixed period and at fixed price only.
Conditions w.r.t. Right Shares
Existing shareholders, who exercise their rights in full, are given an opportunity to apply for additional shares
Existing shareholder who renounce their rights, wholly or partially, are not entitled to apply for additional shares
Share which becomes available, due to non-exercise of rights by some shareholders are allotted to shareholders who have applied for additional shares in proportion to their shareholding
Any balance left after meeting requests for additional shares by the existing shareholders are disposed of at the ruling market price or the issue price, whichever is higher
Right Issue: Impact on Shareholder’s Wealth
The following data pertains to XYZ limited:-
Ordinary Shares 30,00,000Market Price of share Rs. 65/share
Additional share to be issued10,00,000
Proposed Subscription Price Rs. 40/share
Right Issue: Impact on Shareholder’s Wealth
Number of rights required (N)= Existing Share New Shares= 30,00,000 10,00,000= 3 rights
OR 3:1, that means you need to have 3 shares to buy a new share.
Value of a right
R = P0- Ps
N + 1
= 65-40 4
= Rs. 6.25/right= Rs. 6.25 x 3= Rs. 18.75/new share
Value of a share after right issues
Px = So x Po + S x Ps
So + S
Where Px = Price of share after right
So = Number of Existing Shares
S = New sharesPo = Price of share before right issues
Ps = Subscription price of a share
Price of Share after right issue
Px = So x Po + S x Ps
So + S
= (30,00,000 x 65) + (10,00,000 x 40)30,00,000+ 10,00,000
= 19,50,00,000 + 4,00,00,000 40,00,000
= Rs. 58.75/share
Px = N x R + Ps
= 3 x 6.25 + 40
= 58.75/share
Effect of Right issue on the Wealth of SH
There are three options available to the shareholders:- Exercise his right Sell his right Allow rights to expire
Option 1: Exercise Right
Before Right Issue After right Issue
300 shares @ 65/share = 19,500
400 shares @ Rs. 58.75 = 23,500
100 shares @ 40/share = 4,000
Wealth of shareholder = 23,500
Wealth of shareholder = 23,500
Option II: Sell Rights
Before Right Issue After Right Issue
300 shares @ 65 = Rs. 19,500
300 shares @ Rs. 58.75 = Rs. 17,625
100 Shares’ rights @ Rs. 18.75/share =Rs. 1875
Wealth of Shareholder = Rs. 19,500
Wealth of Shareholder = 19,500
Option III: Allows Rights to expire
Before Right Issue After right issue
300 shares @ Rs. 65 = 19,500 300 share @ Rs. 58.75 = 17,625
Wealth of shareholder = Rs. 19,500
Wealth of shareholder = Rs. 17,625