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Chapte R: Long Term Finance: Shares, Debentures and Term Loans
Chapte R: Long Term Finance: Shares, Debentures and Term Loans
LEARNING OBJECTIVES
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Explain the features of ordinary shares Focus on the benefits and valuation of rights shares Discuss the pros and cons of debentures and preference shares Highlight the features of term loans
INTRODUCTION
3
Ordinary
investors. Debentures or bonds provide loan capital to the company, and investors get the status of lenders. Loan capital is also directly available from the financial institutions to the companies.
Ordinary SharesFeatures
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Claim
on Income Claim on Assets Right to Control Voting Rights Pre-Emptive Rights Limited Liability
Advantages
Disadvantages
Public
issue of equity means raising of share capital directly from the public. As per the existing norms, a company with a track record is free to determine the issue price for its shares.
Underwriting of Issues
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It
is legally obligatory to underwrite a public and a rights issue. In an underwriting, the underwritersgenerally banks, financial institution, brokers, etc.guarantee to buy the shares if the issue is not fully subscribed by the public. The agreement may provide for a firm buying by the underwriters. The company has to pay an underwriting commission to the underwriter for their services.
Private Placement
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Private
placement involves sale of shares (or other securities) by the company to few selected investors, particularly the institutional investors.
Private
Selling of Ordinary Shares to the existing shareholders of the company. Value of Right
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(i) he exercises his rights, (ii) he sells his rights, or (iii) he does not exercise or sell his rights.
He
It
is irrelevant in terms of the impact on the shareholders wealth. can be fixed at any level below the current market price.
It
The
primary objective in setting the subscription price low is that after the rights offering, the market price should not fall below it.
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Advantages
1. 2. 3.
Disadvantages
1.
2.
Preference Shares
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2. 3.
Non payment of dividends does not force company to insolvency. Dividends are not deductible for tax purposes. In some cases, it has no fixed maturity dates.
Dividend rate is fixed. Do not share in residual earnings. Preference shareholders have claims on income and assets prior to ordinary shareholders. Usually do not have voting rights.
Similarity to Debentures:
1. 2. 3.
4.
Preference SharesFeatures
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1. 2. 3. 4. 5. 6. 7. 8. 9.
Claims on Income and Assets Fixed Dividend Cumulative Dividend Redemption Sinking Fund Call Feature Participation Feature Voting Rights Convertibility
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Advantages:
Risk less leverage advantage Dividend postponability Fixed dividend Limited Voting Rights
Disadvantages:
DEBENTURES
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debenture is a long-term promissory note for raising loan capital. The firm promises to pay interest and principal as stipulated. The purchasers of debentures are called debenture holders. An alternative form of debenture in India is a bond. Mostly public sector companies in India issue bonds.
DebenturesFeatures
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Interest Rate
Maturity Redemption
Sinking Fund
Buy-back Indenture
(call) provisions
Security
Yield Claims
Types of Debentures
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1. 2.
3.
Advantages:
Less Costly No ownership Dilution Fixed payment of interest Reduced real obligation
Disadvantages:
Term LoansFeatures
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2.
3. 4.
Asset related covenants Liability related covenants Cash flow related covenants Control related covenants