EXTERNAL EQUITY FUNDING SOURCES

Galeeva,G,, Sebastián, A., Solé, E., de Andrés, F. FINANCIAL MANAGEMENT 1

 TEACHING BLOCKS

External equity funding sources

 Capital increase
 Types of Shares
 Concepts
 Important ratios
 Split and reverse split

Galeeva,G,, Sebastián, A., Solé, E., de Andrés, F. FINANCIAL MANAGEMENT 2

 Background on Stockholders’ Equity

• Corporations are business entities authorized in accordance with

state laws
• Stockholders have the right to:
o Vote
o Share in corporate profits
o Share in any assets left at liquidation
o Acquire more shares of subsequent issues of stock
• Stockholders vote to elect the board of directors

Galeeva,G,, Sebastián, A., Solé, E., de Andrés, F. FINANCIAL MANAGEMENT

 Background on Stockholders’ Equity

• A corporate proxy is a written authority granted by shareholders to

have another party cast their votes at the annual meeting

• A preemptive right is the right to acquire a proportional amount of

any new issue of capital stock

• Stockholders have limited liability

o Creditors have claims only on the assets owned by the
corporation
o Stockholders’ personal assets are not at risk

Galeeva,G,, Sebastián, A., Solé, E., de Andrés, F. FINANCIAL MANAGEMENT

 Authorized, Issued, and Outstanding Stock
• The articles of incorporation detail the number of shares and types
of capital stock

• Shares can be:

o Authorized—the total number of shares that can be issued
o Issued—the number of shares exchanged with stockholders
o Outstanding—the number of shares still held by the stockholders

• Treasury shares are shares of the corporation’s own stock which

have been repurchased

Galeeva,G,, Sebastián, A., Solé, E., de Andrés, F. FINANCIAL MANAGEMENT

 Common Stock
• Common stock represents the basic ownership interest in a
corporation. The stockholders bear the major risks and can reap
the major rewards.

• Common stock frequently carries a "par value" set out in the

Corporate Charter or Certificate of Incorporation. This amount is set
by the Board of Directors and is typically quite small.

• The issuing price of a share over and above the par value of the
share is referred to as reserves.

Galeeva,G,, Sebastián, A., Solé, E., de Andrés, F. FINANCIAL MANAGEMENT

 Stock values
• Par value:
o A measure of protection of creditors establishing the minimum
legal capital liability

• Book value
o Historical accumulated accounting value of the stock (includes
capital, retained earnings, and reserves)

• Market value (FINANCE)

o POSITIVE ACCOUNTING
o Values the firm under completely different parameters

Galeeva,G,, Sebastián, A., Solé, E., de Andrés, F. FINANCIAL MANAGEMENT

 Stock Issuance over par

• New share price is higher than the par value:

o Par value - Capital
o Premium (the amount above par value) - Reserves

Example:

If UPS issues an additional 1 million shares of its $.01 par value stock at
$63, the journal entry is:
Cash 63,000,000
Capital (Common stock at par) 10,000
Reserves 62,990,000
Galeeva,G,, Sebastián, A., Solé, E., de Andrés, F. FINANCIAL MANAGEMENT
 Cash Dividends
• Dividends are proportional distributions of income to shareholders

• To pay cash dividends a corporation must have:

o Cash
o Retained earnings

• Dividends must be declared by the board of directors—they are not

automatic

Galeeva,G,, Sebastián, A., Solé, E., de Andrés, F. FINANCIAL MANAGEMENT

 Cash Dividends
• There are three important dates associated with dividends:

o Date of declaration—the date when dividends are announced by

the board

o Date of record—stockholders owning stock on this date receive

the dividend

o Date of payment—the date the company makes payment

Galeeva,G,, Sebastián, A., Solé, E., de Andrés, F. FINANCIAL MANAGEMENT

 Preferred Stock
• Preferred stock offers owners different rights and preferential
treatment
o Dividend preference—preference over dividend claims of
common stockholders
o Liquidation preference—preference to assets in the event of a
liquidation
o Preferred stock does not normally have voting rights

• Par value is significant for preferred stock in cases in which the

dividend is stated as a % of par and/or when the amount due at
liquidation is tied to par.

• Preferred stock is accounted for in the same way as common stock.

Galeeva,G,, Sebastián, A., Solé, E., de Andrés, F. FINANCIAL MANAGEMENT

 Preference in Liquidation
• Preferred stock usually has a liquidation value
o The liquidation value must be paid to preferred stockholders
before distributions to common stockholders when a company is
liquidated
o The liquidation value is often the same as par value

• The company must pay off all debts first

• There is less risk associated with preferred stock than common

stock

Galeeva,G,, Sebastián, A., Solé, E., de Andrés, F. FINANCIAL MANAGEMENT

 Other Features of Preferred Stock
• Participating preferred stock receives a fixed dividend but can
receive dividends above this amount if the company has a good
year

• Callable preferred stock gives the company the right to redeem the
stock at a certain call price

• Convertible preferred stock gives the owner the option to exchange

the preferred shares for common shares

Galeeva,G,, Sebastián, A., Solé, E., de Andrés, F. FINANCIAL MANAGEMENT

 Stock Dividends
• Dividends paid in the corporation’s own shares of common stock

• Require the transfer of an amount from retained earnings (reserves)

to capital

• Result in issuance of additional shares of stock to each shareholder

in proportion to their current holdings.

• Such "dividends" entail:

o Company pays dividend without using cash
o Shareholders sell the awarded free shares or keep them
o Book value of the company is unchanged
o Book value per share decreases

Galeeva,G,, Sebastián, A., Solé, E., de Andrés, F. FINANCIAL MANAGEMENT

 Other Issuances of Common Stock
• Common stock is not always issued for cash

• Common stock can also be issued in:

o Noncash exchanges for assets or services
o Conversions of convertible bonds or preferred stock

• Stock dividends. Common Stock can also increase through pure

accounting changes:
o Change some of the Retained Earnings/Reserves into Common
Stock

Galeeva,G,, Sebastián, A., Solé, E., de Andrés, F. FINANCIAL MANAGEMENT

 Convertible Bonds

• Bonds are sometimes issued with a feature that allows holders to

convert the bond into common stock. Convertible bonds provide the
comfort of a guaranteed return (from the bond) but allow the holder
to become a common stockholder if that option becomes attractive.
This conversion feature causes the bond to carry a lower interest
rate.

Galeeva,G,, Sebastián, A., Solé, E., de Andrés, F. FINANCIAL MANAGEMENT