Common stock: characteristics, valuation, and issuance

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Chapter 8

• Common stock characteristics, valuation, and
  issuance

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Common Stock

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

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Balance Sheet Accounts Associated With C/S

• Par value of C/S
• Contributed capital in excess of par
• Additional paid in capital
• Capital surplus
• Retained earnings ( R/E )
• Book value / share equity
  of shares outstanding

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Rights of Common Stockholders

• Dividend rights
• Asset rights
• Preemptive rights
• Voting rights

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Voting for the Board of Directors

• Majority voting requires more than 50 of the
  votes to elect a director
• Cumulative voting
• Shareholders may concentrate votes on a few
  candidates
• Proxy - signing over your voting rights to
  someone else

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Features of C/S

• C/S classes
• Voting and nonvoting
• Specific ownership
• Stock dividends
• Transfer from R/E account to the C/S and
  additional paid-in capital accounts

• Stock repurchases
• Disposition of excess cash
• Financial restructuring
• Future corporate needs
• Reduction of takeover risk
• Stock splits
• Reverse stock splits

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C/S Advantages and Disadvantages

• Advantages
• Flexible
• Reduced financial leverage
• Lower cost of capital
• Disadvantages
• Diluted EPS
• Expensive

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Investment Banking

• Long-range financial planning
• Timing of security issues
• Purchase of securities
• Marketing of securities
• Arrangement of private loans and leases
• Negotiation of mergers

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How Are Securities Sold?

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

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Other Issuance Costs

• Management time
• Underpricing new equity
• Stock price declines
• Incentives
• Green shoe option

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Registration Requirements

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

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Valuation of C/S

• Capitalized value of the stocks expected stream
  of cash flow during holding period

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Dividend Valuation Models

• Zero growth
• G 0
• Constant growth dividend
• Ke gt g
• Dt D0 ( 1 g )t
• Above-normal growth
• Multiple growth rates

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Zero Growth
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Constant Growth
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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 p0

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Valuing Small Firms

• Nature of business
• History of business
• Economic outlook
• Dividend paying capacity
• Industry

• Earnings capacity
• Book value
• Financial condition
• Majority or minority interest
• Voting or nonvoting

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