Chapter 1

Stock valuation

© 2012 Pearson Education 7-1

 Differences Between Debt and
Equity
• Debt includes all borrowing incurred by a firm, including bonds,
and is repaid according to a fixed schedule of payments.

• Equity consists of funds provided by the firm’s owners (investors

or stockholders) that are repaid subject to the firm’s performance.

• Debt financing is obtained from creditors and equity financing is

obtained from investors who then become part owners of the firm.

© 2012 Pearson Education 7-2

 Differences Between Debt and
Equity: Voice in Management
• Unlike creditors, holders of equity (stockholders) are
owners of the firm.
• Stockholders generally have voting rights that permit
them to select the firm’s directors and vote on special
issues.
• In contrast, debt holders do not receive voting privileges.

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 Differences Between Debt and
Equity: Claims on Income and
Assets
• Equityholders’ claims on income and assets are secondary
to the claims of creditors.
– Their claims on income cannot be paid until the claims of all
creditors, including both interest and scheduled principal
payments, have been satisfied.
• Because equity holders are the last to receive
distributions, they expect greater returns to compensate
them for the additional risk they bear

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 Differences Between Debt and
Equity: Maturity
• Unlike debt, equity capital is a permanent form of
financing.
• Equity has no maturity date and never has to be repaid by
the firm.

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 Differences Between Debt and
Equity: Tax Treatment
• Interest payments to debtholders are treated as tax-
deductible expenses by the issuing firm.
• Dividend payments to a firm’s stockholders are not tax-
deductible.

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 Common and Preferred Stock:
Common Stock
• Common stockholders receive what is left—the remaining—after
all other claims on the firm's income and assets have been satisfied.

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 Common Stock: Par Value

• At any time the total number of shares of common stock

outstanding can be found by dividing the book value of common
stock by the par value.

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 Common Stock: Preemptive
Rights (cont.)
• Rights are financial instruments that allow stockholders
to purchase additional shares at a price below the market
price, in direct proportion to their number of owned
shares.

• Rights are an important financing tool without which

shareholders would run the risk of losing their
proportionate control of the corporation.
• From the firm’s viewpoint, the use of rights offerings to
raise new equity capital may be less costly than a public
offering of stock.
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 Common Stock: Authorized,
Outstanding, and Issued Shares
• Authorized shares are the shares of common stock that a firm’s
corporate charter allows it to issue.
• Outstanding shares are issued shares of common stock held by
investors, this includes private and public investors.
• Treasury stock are issued shares of common stock held by the
firm; often these shares have been repurchased by the firm.
• Issued shares are shares of common stock that have been put into
circulation.
Issued shares = outstanding shares + treasury stock

© 2012 Pearson Education 7-10

 Common Stock: Voting Rights

• Generally, each share of common stock entitles its holder to one

vote in the election of directors and on special issues.
• A proxy statement is a statement transferring the votes of a
stockholder to another party.
• Because most small stockholders do not attend the annual meeting
to vote, they may sign a proxy statement transferring their votes to
another party.

© 2012 Pearson Education 7-11

 Common Stock: Voting Rights
(cont.)
• Nonvoting common stock is common stock that carries no voting
rights; issued when the firm wishes to raise capital through the sale
of common stock but does not want to give up its voting control.

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 • Differentiate between debt and equity
• Discuss the features of common stock

© 2012 Pearson Education 7-13