Lecture 7.ppt

Learning Goals Differentiate between debt and equity. Discuss the rights, characteristics, and features of both ordinary and preference share. Understand the basic ordinary share valuation using zero growth, constant growth, and variable growth models. EQUITY CAPITAL – PREFERRED/COMMON Long term fund, provided by firm’s owner Permanent form of financing No repayment is required Liquidate in the event of bankruptcy Claims on income – after satisfy claims from creditors Claims on asset – after satisfy creditor, government, employee, customer Not tax deductibility Preference Share A hybrid security: It’s like ordinary share - no fixed maturity. Technically, it’s part of equity capital. It’s like debt (quasi-debt) – preference dividends are fixed. Missing a preference dividend does not constitute default, but preference dividends are cumulative. Less risk – fixed periodic payment No voting right Example: Genting issued RM75 million of 8.25% preference share at RM50 per share. RM4.125 is the fixed, annual dividend per share. Firms may have multiple classes of preference, each with different features. Priority: lower than debt, higher than ordinary share. Cumulative: all past unpaid preference share dividends AND current dividend must be paid before any ordinary dividends are declared Non-cumulative: pass dividend not accumulate, current paid must be paid before common stock. Protective provisions are common. Convertibility: many preference are convertible into ordinary shares. Adjustable rate preference have dividends tied to interest rates. Participation: some (very few) preference have dividends tied to the firm’s earnings. PIK Preference: Pay-in-kind preference shares pay additional preference shares to investors rather than cash dividends. Retirement: Most preference are callable, and many include a sinking fund provision to set cash aside for the purpose of retiring preference shares. Callable after certain period of time at specific price. Preference Share Valua