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Internally
generated
(Retained
earnings)
Equity
(Long Term)
Sources of
Ordinary shares, long term
Preference shares
finance

Sources of
Finance Long term debt

EQUITY
(Bonds)

Debt Medium term Sources of

(Short, Medium & debt (Leasing, medium
Long Term) Hire purchase) term finance
CHAPTER 7b
Short term debt Sources of
(Trade Credit, short term
Overdraft) finance

Features of Ordinary Shares

• A common stock is an equity investment that
represents ownership in a corporate form of
business.
• Each share represents a fractional ownership (i) Residual Claim
interest in the firm.
Common Stock • The key attribute of this investment security is that it
• In case of bankruptcy,
shareholder is the last to be
enables investors to participate in the profits of the
(Ordinary Shares) firm. paid after payment made to
bondholders and preferred
• Any income generated by the company belongs to stockholders.
owners.
• Dividend payment only after
• Owners are called shareholders or stockholders.
bondholders and preferred
• Example: Purchase of Public bank shares means stockholders are paid first.
ownership of the company.

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Features of Ordinary Shares
(ii) Voting Rights
• Common shareholders are allowed to vote on important matters.
• Public listed companies are required by law to have the Annual
General Meeting (AGM) to approve the company accounts,
appointment of auditors and Board of Director (BOD).
• Power of vote depend on the number of shares held by
shareholders.
Features of Ordinary Shares
(iv) Authorisation to issue new common stock
• Additional capital to be raised via rights issue.
(v) Ordinary shares are easy to buy and sell, and the transactions costs
are modest.
(vi) Price and market information is widely disseminated in the news and
financial media.
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Features of Ordinary Shares
(iii) No maturity
• It is held in perpetuity (no fixed maturity date).
• If shareholders pass away, the share will be inherited by
their next of kin (a person's closest living relatives).
Advantages of Common Stock from
Investor’s Viewpoint
(i) There is no limit to a stock’s capital gains potential
• Higher return due to higher risk
• Average returns are 9 -15 % averagely in 10 years period.
(ii) Dividend yield
• Stocks can provide regular current income in the form of annual dividends.
• However, not all shares pay dividend (if company has less income or during recession).
• For most income-producing stocks, those dividends tend to grow over time, adding
even more to the stockholder’s return.
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Advantages of Common Stock from Advantages of Common Stock from

Investor’s Viewpoint Investor’s Viewpoint

(vi) Pre-emptive rights

(iii) Common stocks are highly liquid and easily transferable
• If you own 10% shares of a company and the company wants to issue new
• Compared to bonds, shares are easier to sell as it is listed on the Bursa Malaysia.
shares, the company must give first right of refusal to existing shareholders
• The transaction costs are relatively low.
based on the number of shares that they hold.
• Shareholders are offered to buy the new shares with price below its market
(vi) Market information is readily available
price before the new shares are issued to public.
• Information is release to the public in financial newspaper.

(vii) No maturity date

(v) Voting Rights
• As shareholders are owners of the company, they are entitled to voting rights (in • Held in perpetuity – can be passed down to next of kin.
election on BOD and company administrative decision making).

Disadvantages of Common Stock to Investor Types of Shares

(i) Common stocks are risky

• Share prices are volatile as prices are subject to wide swings.
• Blue-chip shares
• Shares that are unsurpassed in quality and have a long and stable record of earnings
and dividends.
(ii) As residual owners of the firm, no return is guaranteed • E.g. Nestle (Malaysia) Berhad
• In case of bankruptcy, bondholders and preference shareholders have to be paid first.
• Growth shares
(iii) Dividend is not guaranteed • Shares that experienced, and are expected to continue experiencing, consistently
high rates of growth shares.
• May not receive income (if company has less income or during recession).

(iv) Acquisition of common stock may result in ownership control

• Income shares
• Shares that have a long and sustained record of regularly paying higher-than-
• Shareholders may lose control of the company if a person purchases shares in the market and average dividends.
becomes a major shareholder or director of the company.

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Types of Shares (Cont’d) Types of Shares (Cont’d)

• Defensive shares
• Speculative shares
• Shares whose price remain stable or even increase when general economic
• Shares that lack sustained records of success but still offer the potential activity is tapering off.
for substantial price appreciation. • E.g. shares in utility sector like Tenaga Nasional Bhd (TNB).

• Cyclical shares • Large-cap shares

• Shares issued by companies whose earnings are closely linked to • Shares that with a large market capitalisation value of more than $10 billion.
general level of business activity.
• E.g. shares in oil and gas (O&G) industry, property, etc.
• Small-cap shares
• Shares whose market capitalisation is relatively small in the market.

Investment Strategies

• Buy-and-Hold
• Place money in a secure investment and watch it grow over time.

Preferred Shares
• High-quality shares that offer attractive current income and/or capital gains and
hold them for extended periods – perhaps as long as 10 to 15 years.

• Current Income
• Seek high levels of current income.
• Shares which dividend tend to increase over time. Preferred stock is known as a hybrid security because
it has both debt and equity characteristics.
• Speculation and Short-Term Trading
• Seek capital gains within a short period.
• Speculative or small-cap shares and tech shares.

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Advantages and Disadvantages of Preferred

Features of Preferred Shares
Fixed dividend
Omission
Cumulative dividends
Convertibility
No voting rights
Shares
Advantages Disadvantages
• It pays fixed dividend before common stock dividends.
 Since preferred stock obligates the firm to  Since holders of preferred stock are given
pay only fixed dividends to its holders, its preference over common stockholders with
presence helps to increase the firm’s respect to distribution of earnings and
• If the preferred dividend is not earned, the directors can omit it without
putting the company into bankruptcy. financial leverage. assets, the presence of preferred stock in a
sense jeopardises (threatens or harm)
 Although preferred stock provides added common stockholders’ returns.
• Most preferred stock is cumulative with respect to any dividends passed.
That is, all dividends in arrears must be paid to preferred stockholder
before the payment of dividends made to common stockholders.
leverage in much the same way as bonds, it
differs from bonds in that the issuer can  Preferred stock dividends are not
pass a dividend payment without putting deductible to the issuer; consequently, the
the company into bankruptcy. after-tax cost of preferred is typically higher
• Preferred stock quite often contains a conversion feature that permits its
transference into a specified number of shares of common stock. than the after-tax cost of debt.
 Since preferred stock sometimes has no
maturity, preferred stock avoids the cash
• They are normally not given the right to vote in the company’s
administrative decision.
flow drain from repayment of principal that
is inherent in debt issues.

Equity vs Debt Financing Equity vs Debt Financing

• To raise capital for business needs, companies primarily have two types of
• Equity Financing
financing as an option: equity financing and debt financing.
Company may raise share capital. Most new
• Most companies use a combination of debt and equity financing. issues of share capital are in the form of
ordinary share capital and shareholders are
the owners or members of the company.
A=L+E Firms that issue ordinary share capital are
inviting investors to take an equity stake in
the business.
L
Financing decision/activity
(Capital Structure)
• Debt Financing
A Company may raise loan capital either short,
? % of debt financing (liabilities) medium or long-term such as bank loans
? % of equity financing and bonds. The lender will usually want
E some security for the loan and specify the
security. Most loans have a fixed term to
maturity. 6-20

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IF a company decides to use:

• Equity financing
• the owners would have to give up more ownership, reducing their share of
future profits and decision-making power.

• Debt financing
• their monthly expenses would be higher, leaving less cash on hand to use for
other purposes, as well as a larger debt burden that it would have to pay back
with interest.

Therefore, businesses MUST determine which option or combination is

the best for them.