7-1

Debt refers to all money received from creditors, while equity is money gained by stockholders.
Key differences between debt and equity-free:
1. Voice management - Stockholders can participate in management decisions and
corporate activities, but creditors do not. They are merely attempting to collect their
loan.
2. Claims on income and assets - Regarding collecting, creditors have priority over
investors. If a corporation declares bankruptcy, creditors are the first to be paid,
whereas investors are paid only at the end, if feasible.
3. Maturity - Debt instruments always have a maturity (the period over which they must
be repaid), whereas stocks do not.
4. Tax treatment - Interest paid on debt to creditors is subject to tax release. However,
dividends provided to stockholders are not tax deductible.
7-2
Stockholders commit to "share the destiny" of a firm by investing in its stocks.
For example, by acquiring stocks, investors get voting power in a company and the ability to
decide on the firm's destiny, but they also risk losing all of the money invested in stocks.
This is because, unlike debt holders, investors are not guaranteed to be repaid. Dividends can
but do not have to, be paid annually.
Furthermore, if the firm declares bankruptcy, debt holders can recover their debts, but
investors would only be compensated if there is any remaining money.
As a result, stockholders are taking a significant risk by investing in the company, as they are
not guaranteed any future income. Still, they are willing to invest because they believe the
company will perform well and they will receive a portion of the profits, as well as that the
stock prices will rise, allowing them to resell them and realize capital gains.
7-3
When a corporation issues new stock, it increases the overall number of stocks, reducing the
percentage of each given stock in its overall equity.
This results in a dilution of ownership, which means that current shareholders will end up with
a lesser percentage of total stocks and, as a result, a smaller share of the company's earnings
and dividends.
To safeguard its current stockholders, the firm offers them a rights offering, which implies that
with each new issue of stocks, existing stockholders will have the right to purchase new stocks
at a lower price than the market price.
In order to keep that stake in the future, each existing shareholder is issued a number of new
stocks equivalent to its present part of the overall equity.
7-4
Authorized shares - Stockholders vote to authorize the number of shares a firm can issue later.
The corporation is not required to issue all of the approved stock immediately, but authorized
stock becomes outstanding shares once issued.
Treasury stock - The corporation may opt to repurchase its stock from the market, which will be
returned to the company.
Issued shares - are the total of outstanding and treasury stocks since both were issued at some
point in the past, even though the treasury stocks have subsequently been repurchased.
7-5
The major advantages of issuing stocks outside the company's native market stem from
widening the structure of shareholders and people with a say in the company's future
operations.
In addition, if the corporation wishes to purchase a smaller company in the local market, its
shares might be used as payment.
Due to US market legal constraints, trading with non-US equities in the US market is extremely
tough.
As a result, American depositary shares are created. They are the receipts for the equities of
non-US corporations held by US international funds.
American depositary receipts are securities created based on American depositary shares that
allow US investors to hold the shares of non-US corporations.
7-6
When it comes to dividends (distribution of earnings), preferred stockholders have the upper
hand over regular stockholders.
This implies that when the dividend is paid, preferred investors will be among the first to
receive it.
Furthermore, in the event of the company's bankruptcy, preferred investors will enjoy senior
rights to the company's assets over common stockholders.
The proceeds from the sale of the company's assets will be utilized first to repay preferred
investors and, subsequently, common stockholders.
7-7
The dividend distributions are referred to as the preferred stock's cumulative feature. Before
any ordinary stockholder may get their dividend, preferred equities with the cumulative feature
are awarded the cumulative dividend payment for all past periods.
The current dividend is paid if the preferred stock lacks the cumulative characteristic.
The call feature of preferred stock allows the investor to resell his share at a specified future
date and price.

This price is frequently greater than the price that the shareholder initially paid for the stock,
and it so provides the stockholder with a fixed income in the future, making it analogous to a
debt instrument.
7-8
Venture capitalists are often legal entities (other firms) that significantly impact the startup's
future operations by interfering with management choices. On the other hand, Angel capitalists
are often affluent individuals who offer funding but are not as involved in the company's
operations and development.
7-9
1. Small business investment companies - Small businesses that get capital by borrowing
from the US Treasury at favourable terms and investing in startups.
2. Financial VC funds - Typically, subsidiaries of financial firms, such as banks or investment
funds, invest in startups with the expectation that they would grow into successful
businesses and clients of the bank.
 3. Corporate VC funds - Non-financial firms create subsidiaries to invest in potential
startups, often to obtain access to innovative technology.
4. VC limited partnerships - Partnerships formed in order to invest in potential new
businesses. The partnership is dissolved when the new firm becomes profitable, and the
partners' shares are distributed.
The VC agreements are structured to give the VC authority over the financed firm and its
present owners and founders.
The firm's financing might be structured around particular milestones, which means the
company must achieve certain stages or complete certain projects before receiving the next
tranche of VC funding.
7-10
Before going public, the corporation must meet the following requirements:
 getting permission from the company's present investors
 Receiving legal clearance that all documents are legitimate
 Finding an investment bank willing to be an underwriter for the issue, which means
assisting in the sale of the stocks and locating investors
7-11
When a firm intends to go public or list its shares on a market exchange, it must locate an
investment banker to oversee the underwriting process.
The underwriting method is a process in which an investment banker assures a firm that it will
be able to sell its shares at a specific price.
Because the lender initially purchases the shares from the issuing firm, he also assumes the risk
of reselling these stocks and finding qualified purchasers prepared to pay the requested price.

Because this is frequently the company's first time doing such transactions, the investment
banker also serves as a counsellor to the firm that is going public.
The underwriting syndicate is created when the number and volume of issued stocks surpass
the capabilities of a single investment banker. This syndicate is made up of multiple banks that
have agreed to share the risk of reselling equities as well as the rewards.
7-12
An efficient market is one in which all essential information is available to all interested
investors who can appropriately evaluate it and base their investment decisions on it.
As a result, if fresh information indicates that the return on a certain asset will be greater than
the required one, all investors will desire to own such an item.
As a result of the strong demand for this item, the price (the market value of this asset) will rise.
7-13
According to the efficient market hypothesis, an efficient market is one in which all essential
information is available to all interested investors who can appropriately understand it and
base their investment decisions on it.
1. Regarding security pricing, EMH informs us that all prices are in equilibrium, which
means that they represent all available information useful for deciding the price of a
security.
 2. EMH also tells us that the prices of all securities in the market react quickly to new
important information that appears. This is because all information is expected to be
reliable and equally available to all market participants.
3. Another assumption that EMH teaches us is that all investors understand how to
analyze all relevant information properly. As a result, we are certain that all prices are
fair and will not waste time looking for opportunities to benefit from mispriced assets.
According to behavioural finance theory, market players are not totally rational, and so their
investment decisions are not either. Their judgments are heavily influenced by some unique
psychological effect on each investor.
This hypothesis opposes the EMH since one of its fundamental assumptions is that all investors
are totally rational.
7-14
1. Zero-growth
As the name implies, this strategy believes that dividends will not grow over time, implying that
they will remain constant.

2. Constant-growth
The term implies that future payouts will rise at a steady rate in subsequent years. This rate
must be lower than the necessary rate of return.
 3. Variable-growth
The term implies that future payouts will rise at variable (changing) rates in the future.
7-15
The free cash valuation methodology calculates the stock's worth based on the present value of
all future benefits that the stock is predicted to bring to its owner. However, unlike the dividend
valuation model, the free cash valuation model focuses on assessing the firm's total worth
rather than the shares itself.
The free cash flow valuation methodology calculates a company's worth as the present value of
all future free cash flows (cash flows accessible to shareholders) reduced by the estimated cost
of future funding (the weighted average cost of capital).

7-16
1. Book value
It shows the share's worth based on accounting data for the company's equity.
It is computed by dividing the balance sheet equity by the number of outstanding shares.
This model is rarely utilized since it is based only on accounting data and does not include the
market value of the share or the company's future potential.
1. Liquidation Value
Evaluate a share's value as the amount of money each shareholder would get if the firm went
bankrupt.
In this situation, the market worth of all assets is calculated, then all debt and preferred shares
are paid off, and what is left is split evenly among the common shareholders.
This approach considers the market worth of the company's assets but ignores future
possibilities.
1. Price/earnings (P/E) multiples
Evaluate the stock's worth by multiplying the supplied firm's predicted earnings per share (EPS)
by the industry's average P/E ratio.
Rating agencies often provide data on industry average P/E ratios, although predicted profits
per share may be approximated, which firms typically reveal (through their budgets and other
announcements).
There is no one proper answer when selecting which of the given models is the best since there
is no single truth' on this topic because we are largely dealing with estimations.
The best approach for determining the value of the company's shares is a mix of several distinct
methodologies.
7-17
The stock's worth is determined by the present value of all future advantages that the stock is
projected to bring to its owner.
Because of the direct relationship between the company's projected return (the future rewards
for the shareholders) and the risk (which is used to determine the needed return and the
discount factor), any change in any of these two causes the stock value to fluctuate.
As a result, if the finance management makes a financial choice that affects either the
company's future profits or investors' risk perceptions, the stock price will be affected.
7-18
1. The firm's risk premium increases - When calculating the present value of the company's
future returns, the risk premium is employed as a discount factor. As a result, any rise in
the risk premium would cause the stock price to fall.
 2. The firm's required return decreases - When calculating the present value of the
company's future returns, the needed return is employed as a discount factor. As a
result, any fall in the risk premium would cause the stock price to rise.
3. The dividend expected next year decreases - The dividend is the primary reward that
every investor anticipates when acquiring stock. As a result, any reduction in future
dividends reflects a reduction in the advantages for investors and, as a result, a decline
in the stock price.
4. The rate of growth in dividends is expected to increase - The dividend is the primary
reward that every investor anticipates when acquiring a stock. As a result, every
increase in future dividends reflects an increase in the advantages for investors, which
will drive the stock price to rise.

------------

7-1

Debt referred to all moneys received from creditors while equity is money gained by stockholders.

Key differences between debt and equity free:

1. Voice management - Stockholders have the right to participate in management decisions and
corporate activities, but creditors do not. They are merely attempting to collect their loan.
2. Claims on income and assets - When it comes to collecting, creditors have priority over
investors. If a corporation declares bankruptcy, creditors are the first to be paid, whereas
investors are paid only at the end, if feasible.
3. Maturity - Debt instruments always have a maturity (the period over which they must be
repaid), whereas stocks do not.
4. Tax treatment - Interest paid on debt to creditors is subject to tax release, however dividends
provided to stockholders are not tax deductible.

7-2

Stockholders commit to "share the destiny" of a firm by investing in its stocks.

That example, by acquiring stocks, investors get voting power in a company and the ability to decide on
the firm's destiny, but they also risk losing all of the money invested in stocks.

This is because, unlike debt holders, investors are not guaranteed to be repaid. Dividends can, but do
not have to, be paid annually.

Furthermore, if the firm declares bankruptcy, debt holders will be able to recover their debts, but
investors would only be compensated if there is any money remaining.

As a result, stockholders are taking a significant risk by investing in the company, as they are not
guaranteed any future incomes, but they are willing to invest because they believe the company will
perform well and they will receive a portion of the profits, as well as that the stock prices will rise,
allowing them to resell them and realize capital gains.
7-3

When a corporation issues new stock, it increases the overall number of stocks, which reduces the
percentage of each given stock in the company's overall equity.

This results in dilution of ownership, which means that current shareholders will end up with a lesser
percentage of total stocks and, as a result, a smaller share of the company's earnings and dividends.

To safeguard its current stockholders, the firm offers them a rights offering, which implies that with each
new issue of stocks, existing stockholders will have the right to purchase new stocks at a lower price
than the market price.

In order to keep that stake in the future, each existing shareholder is issued a number of new stocks
equivalent to its present part of the overall equity.

7-4

Authorized shares - Stockholders vote to authorize the quantity of shares that a firm can issue later.

The corporation is not required to issue all of the approved stock immediately, but once issued,
authorized stock becomes outstanding shares

Treasury stock - The corporation may opt to repurchase its stock from the market, and these stocks will
be returned to the company.

Issued shares - are the total of outstanding and treasury stocks since both of these stocks were issued at
some point in the past, even though the treasury stocks have subsequently been repurchased.

7-5

The major advantages of issuing stocks outside the company's native market stem from widening the
structure of shareholders and people with a say in the company's future operations.

In addition, if the corporation wishes to purchase a smaller company in the local market, its shares might
be used as payment.

Due to US market legal constraints, trading with non-US equities in the US market is extremely tough.

As a result, American depositary shares are created. They are the receipts for the equities of non-US
corporations held by US international funds.

American depositary receipts are securities created on the basis of American depositary shares that
allow US investors to hold the shares of non-US corporations.

7-6

When it comes to dividends (distribution of earnings), preferred stockholders have the upper hand over
regular stockholders.

This implies that when the dividend is paid, preferred investors will be among the first to receive it.

Furthermore, in the event of the company's bankruptcy, preferred investors will enjoy senior rights to
the company's assets over common stockholders.
The proceeds from the sale of the company's assets will be utilized first to repay preferred investors and
subsequently to repay common stockholders.

7-7

The dividend distributions are referred to as the preferred stock's cumulative feature. Before any
ordinary stockholder may get his dividend, preferred equities with the cumulative feature are awarded
the cumulative dividend payment for all past periods.

If the preferred stock lacks the cumulative characteristic, just the current dividend is paid.

The call feature of preferred stock allows the investor to resell his share at a specified future date and
price.

This price is frequently greater than the price that the shareholder initially paid for the stock, and it so
provides the stockholder with a fixed income in the future, making it analogous to a debt instrument.

7-8

Venture capitalists are often legal entities (other firms) that have a significant impact on the startup's
future operations through interfering with management choices. Angel capitalists, on the other hand,
are often affluent individuals who offer funding but are not as involved in the company's operations and
development.

7-9

1. Small business investment companies - Small businesses that get capital by borrowing from the
US Treasury at favorable terms and investing in startups.
2. Financial VC funds - Typically, subsidiaries of financial firms, such as banks or investment funds,
invest in startups with the expectation that they would grow into successful businesses and
clients of the bank.
3. Corporate VC funds - Non-financial firms create subsidiaries to invest in potential startups, often
to obtain access to innovative technology.
4. VC limited partnerships - Partnerships formed in order to invest in potential new businesses.
When the new firm becomes profitable, the partnership is dissolved and the partners' shares
are distributed.

The VC agreements are structured in such a manner that they give the VC authority over the financed
firm, together with its present owners and founders.

The firm's financing might be structured around particular milestones, which means that the company
must achieve certain stages or complete certain projects before receiving the next tranche of VC
funding.

7-10

Before going public, the corporation must meet the following requirements:

 getting permission from the company's present investors

  receiving legal clearance that all documents are legitimate
 finding an investment bank willing to be an underwriter for the issue, which means assisting in
the sale of the stocks and locating investors

7-11

When a firm intends to go public, or list its shares on a market exchange, it must locate an investment
banker to oversee the underwriting process.

The underwriting method is a process in which an investment banker assures a firm that it will be able to
sell its shares at a specific price.

Because the lender initially purchases the shares from the issuing firm, he also assumes the risk of
reselling these stocks and finding qualified purchasers prepared to pay the requested price.

Because this is frequently the company's first time doing such transactions, the investment banker also
serves as a counselor to the firm that is going public.

The underwriting syndicate is created when the number and volume of issued stocks surpass the
capabilities of a single investment banker. This syndicate is made up of multiple banks who have agreed
to share the risk of reselling equities as well as the rewards.

7-12

An efficient market is one in which all essential information is available to all interested investors who
can appropriately evaluate it and base their investment decisions on it.

As a result, if fresh information emerges indicating that the return on a certain asset will be greater than
the required one, all investors will desire to own such an item.

As a result of the strong demand for this item, the price (the market value of this asset) will rise.

7-13

According to the efficient market hypothesis, an efficient market is one in which all essential information
is available to all interested investors who can appropriately understand it and base their investment
decisions on it.

a. In terms of security pricing, EMH informs us that all prices are in equilibrium, which means that
they really represent all available information useful for deciding the price of a security.
b. EMH also tells us that the prices of all securities in the market react quickly to new important
information that appears. This is because all information is expected to be reliable and equally
available to all market participants.
c. Another assumption that EMH teaches us is that all investors understand how to properly
analyze all relevant information and, as a result, are certain that all prices are fair and will not
waste time looking for opportunities to benefit from mispriced assets.
According to behavioral finance theory, market players are not totally rational, and so their investment
decisions are not either. Their judgments are heavily influenced by some psychological effect that is
unique to each investor.

This hypothesis opposes the EMH since one of its fundamental assumptions is that all investors are
totally rational.

7-14

a. Zero-growth

As the name implies, this strategy believes that dividends will not grow over time, implying that they
would remain constant.

b. Constant-growth

The term implies that future payouts will rise at a steady rate in subsequent years. This rate must be
lower than the necessary rate of return.
 c. Variable-growth

The term implies that future payouts will rise at variable (changing) rates in the future.
7-15

The free cash valuation methodology calculates the stock's worth based on the present value of all
future benefits that the stock is predicted to bring to its owner. However, unlike the dividend valuation
model, the free cash valuation model focuses on assessing the total worth of the firm rather than the
shares itself.

The free cash flow valuation methodology calculates a company's worth as the present value of all
future free cash flows (cash flows accessible to shareholders) reduced by the estimated cost of future
funding (the weighted average cost of capital).

7-16

a. Book value

It shows the share's worth based on accounting data for the company's equity.

It is computed by dividing the balance sheet equity by the number of outstanding shares.

This model is rarely utilized since it is based only on accounting data and does not include the market
value of the share or the company's future potentials.

b. Liquidation value

evaluates the value of a share as the amount of money that each shareholder would get if the firm went
bankrupt.

In this situation, the market worth of all assets is calculated, then all debt and preferred shares are paid
off, and what is left is split evenly among the common shareholders.

This approach takes into account the market worth of the company's assets but ignores future
possibilities.

c. Price/earnings (P/E) multiples

evaluates the stock's worth by multiplying the predicted earnings per share (EPS) of the supplied firm by
the industry's average P/E ratio.

Rating agencies often provide data on industry average P/E ratios, although predicted profits per share
may be approximated, which firms typically reveal (through their budgets and other announcements).

There is no one proper answer when selecting which of the given models is the best, since there
is no'single truth' on this topic because we are largely dealing about estimations.

The best approach for determining the value of the company's shares would most likely be a mix of
several distinct methodologies.

7-17
The stock's worth is determined by the present value of all future advantages that the stock is projected
to bring to its owner.

Because of the direct relationship between the company's projected return (the future rewards for the
shareholders) and the risk (which is used to determine the needed return and the discount factor), any
change in any of these two causes the stock value to fluctuate.

As a result, if the finance management makes a financial choice that affects either the company's future
profits or the risk perceptions of investors, the stock price will be affected.

7-18

a. The firm’s risk premium increases - When calculating the present value of the company's future
returns, the risk premium is employed as a discount factor. As a result, any rise in the risk
premium would cause the stock price to fall.
b. The firm’s required return decreases - When calculating the present value of the company's
future returns, the needed return is employed as a discount factor. As a result, any fall in the risk
premium would cause the stock price to rise.
c. The dividend expected next year decreases - The dividend is the primary reward that every
investor anticipates when acquiring a stock. As a result, any reduction in future dividends
reflects a reduction in the advantages for investors and, as a result, a decline in the stock price.
d. The rate of growth in dividends is expected to increase - The dividend is the primary reward that
every investor anticipates when acquiring a stock. As a result, every increase in future dividends
reflects an increase in the advantages for investors, which will drive the stock price to rise.