long term

EQUITY
CHAPTER 7b
Key Financial Decisions / Activities
Statement of Financial Position /
Balance Sheet

Assets Shareholders’ Equities

- Equity
◦ Fixed assets
Liabilities
◦ Current assets
◦ Long term liabilities
- Cash
- Bonds
- Accounts Receivables
◦ Current liabilities
- Inventory
A=L+E
Investment Financing decision/activity
Left decision/activity Right
(Capital Structure)
 Internally
generated
(Retained
earnings)
Equity
(Long Term)
Sources of
Ordinary shares, long term
Preference shares
finance

Sources of
Finance Long term debt
(Bonds)

Debt Medium term Sources of

(Short, Medium & debt (Leasing, medium term
Long Term) Hire purchase) finance

Short term debt Sources of

(Trade Credit, short term
Overdraft) finance
 • A common stock is an equity investment that
represents ownership in a corporate form of
business.
• Each share represents a fractional ownership
interest in the firm.
Common Stock • The key attribute of this investment security is that it
enables investors to participate in the profits of the
(Ordinary Shares) firm. pay dividend and receivers are participate

• Any income generated by the company belongs to

owners.
• Owners are called shareholders or stockholders.
• Example: Purchase of Proton shares means
ownership of the company.
Features of Ordinary Shares
=Characteristics

if have any remainer, you can claim

(i) Residual Claim

• In case of bankruptcy,
convert assets to cash
shareholder is the last to be
coupon paid after payment made to
bondholders and preferred
dividend stockholders.
• Dividend payment only after
dividend
bondholders and preferred
stockholders are paid first.
Features of Ordinary Shares

(ii) Voting Rights 100 units=0.0001%

• 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.
 LT

Features of Ordinary Shares

(iii) No maturity
forever

• 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).
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. transparent and easily to see
Advantages of Common Stock from
Investor’s Viewpoint
100

20
(i) There is no limit to a stock’s capital gains potential
RM1
• Higher return due to higher risk Buy lower prices and sell higher prices

• Average returns are 9 -15 % averagely in 10 years period.

losses will be limited (no negative)
Gain unlimited

(ii) Dividend yield If share prices not increase and remain unchange, you are wait for company give dividend to gain income
• 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.
Advantages of Common Stock from
Investor’s Viewpoint

(iii) Common stocks are highly liquid and easily transferable

• Compared to bonds, shares are easier to sell as it is listed on the Bursa Malaysia.
• The transaction costs are relatively low. nowdays click buy click sell

(vi) Market information is readily available easily let investor get information to analysis

• Information is release to the public in financial newspaper.

(v) Voting Rights

• As shareholders are owners of the company, they are entitled to voting rights (in
election on BOD and company administrative decision making)
Advantages of Common Stock from
Investor’s Viewpoint if existing shareholders don't want to buy, company will
issue new shares open to public

company must give existing shareholders to

(vi) Pre-emptive rights protect existing shareholders
100k unit
------------- = 10%
buy.e.g. if current share have 10%,you can
buy 10%new share.
1mil units
• If you own 10% shares of a company and the company wants to issue new
shares, the company must give first right of refusal to existing shareholders
based on the number of shares that they hold. prefer don't want to buy( refuse to buy)

• Shareholders are offered to buy the new shares with price below its market
price before the new shares are issued to public.

(vii) No maturity date

• Held in perpetuity – can be passed down to next of kin
Disadvantages of Common Stock to Investor

(i) Common stocks are risky

high risk high return
• Share prices are volatile as prices are subject to wide swings.

(ii) As residual owners of the firm, no return is guaranteed

• In case of bankruptcy, bondholders and preference shareholders have to be paid first.

(iii) Dividend is not guaranteed

• May not receive income (if company has less income or during recession). you cannot get dividend

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

• Shareholders may lose control of the company if a person purchases shares in the market and
becomes a major shareholder or director of the company.
today A become a major shareholder, tomorrow may B
become major shareholder
 Types of Shares

1 • Blue-chip shares
• Shares that are unsurpassed in quality and have a long and stable record of earnings
and dividends.
• E.g. Nestle (Malaysia) Berhad

2 • Growth shares
• Shares that experienced, and are expected to continue experiencing, consistently
opposite
high rates of growth shares.

3 • Income shares growth

• Shares that have a long and sustained record of regularly paying higher-than-
average dividends. if growth money, they will pay dividend
 Types of Shares (Cont’d)

4 • Speculative shares
• Shares that lack sustained records of success but still offer the potential
for substantial price appreciation. no earn profit in annual report
-no stable
-high risk
5 • Cyclical shares Day 1 Day 2 Day 3 Day4

• Shares issued by companies whose earnings are closely linked to

general level of business activity. follow movement of economy
• E.g. shares in oil and gas (O&G) industry, property, etc.
 Types of Shares (Cont’d)

6 • Defensive shares
• Shares whose price remain stable or even increase when general economic
activity is tapering off.
• E.g. shares in utility sector like Tenaga Nasional Bhd (TNB).
although economic not well, but they still
stable
7 • Large-cap shares share price x no.of shares
• Shares that with a large market capitalization value of more than $10 billion.

8 • Small-cap shares
• Shares whose market capitalization is relatively small in the market.
Investment Strategies

• Buy-and-Hold
LT

• Place money in a secure investment and watch it grow over time

• 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 div

• Seek high levels of current income

• Shares which dividend tend to increase over time

• Speculation and Short-Term Trading

• Seek capital gains within a short period ST RISK
• Speculative or small-cap shares and tech shares
 Equity

Preferred Shares
Preferred stock is known as a hybrid security because
it has both debt and equity characteristics.

Features of Preferred Shares
similar to debt-bond
Fixed dividend
Omission
Cumulative dividends
Convertibility
No voting rights
like debt
Hybrid
•It pays fixed dividend before common stock dividends.
•If the preferred dividend is not earned, the directors can omit it without
putting the company into bankruptcy. shareholder cannot sue you
•Most preferred stock is cumulative with respect to any dividends passed.
That is, all dividends in arrears must be paid before any payment of
dividends to common stockholders.
if year 1 never earn money,they can omit it.
carry forward to next year(5%year this year and
5%previous year)
•Preferred stock quite often contains a conversion feature that permits its
transference into a specified number of shares of common stock.
•They are normally not given the right to vote in the company’s
administrative decision.
 bond coupon

Advantages and Disadvantages of Preferred

Shares if only have bondholders, ordinary holders will feel ok.
if preference holders in the company,ordinary holders need to wait company
pay to bondholders and preference holders before pay to them

Advantages
 Since preferred stock obligates the firm to
pay only fixed dividends to its holders, its
presence helps to increase the firm’s
financial leverage. company perspective
 Although preferred stock provides added
leverage in much the same way as bonds, it
differs from bonds in that the issuer can
pass a dividend payment without putting
the company into bankruptcy.
company perspective
 Since preferred stock sometimes has no
maturity, preferred stock avoids the cash
flow drain from repayment of principal that
is inherent in debt issues. company perspective
Disadvantages
 Since holders of preferred stock are given
preference over common stockholders with
respect to distribution of earnings and
assets, the presence of preferred stock in a
sense jeopardises (threatens or harm)
common stockholders’ returns. company perseptive
 Preferred stock dividends are not
deductible to the issuer; consequently, the
after-tax cost of preferred is typically higher
than the after-tax cost of debt. company perseptive
Sales
- exp
--------------
profit
- tax
Equity vs Debt Financing

• To raise capital for business needs, companies primarily have two types of
financing as an option: equity financing and debt financing.
• Most companies use a combination of debt and equity financing.
A=L+E

financing
investment
L
Financing decision/activity
60% (Capital Structure)
A
? % of debt financing (liabilities)
? % of equity financing
E
100%

40%
Equity vs Debt Financing

• Equity Financing
Company may raise share capital. Most new
issues of share capital are in the form of
ordinary share capital and shareholders are
the owners or members of the company.
Firms that issue ordinary share capital are
inviting investors to take an equity stake in
the business.

• Debt Financing
Company may raise loan capital either short,
medium or long-term such as bank loans
and bonds. The lender will usually want
some security for the loan and specify the
security. Most loans have a fixed term to
maturity. 6-21
Think about these before taking a debt
financing… 90%
obligation

• What if your company hits hard times or the economy, once

again, experiences a meltdown?
• What if your business does not grow as fast or as well as you
expected?
interest
• Debt is an expense and you have to pay expenses on a regular
schedule.
• This could put a damper (limit/restrict) on your company's ability
to grow.
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. not necessary