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  • 1. By
    MaroofHussainSabri
    Sources of Finance
  • 2. Sources of Finance
    2
    MaroofHussainSabri
  • 3. Equity Financing
    Maroof Hussain Sabri
    3
  • 4. Equity Financing
    Generation of funds for business from the OWNERS of the business.
    Broadly, Major Sources are:
    Maroof Hussain Sabri
    4
  • 5. Retained Earnings
    Maroof Hussain Sabri
    5
  • 6. Retained Earnings
    Retained earnings, unappropriated profits, accumulated profits or retained profits.
    Most important form of equity financing
    Low Cost
    Can be Cash or short-term investments
    Problems:
    May not be enough if company is trying to grow.
    Difficulty to retain sufficient earnings if shareholders require to maintain or increase dividend levels
    MaroofHussainSabri
    6
  • 7. Equity Shares & Markets
    Maroof Hussain Sabri
    7
  • 8. Stock Market
    Stock Market
    Stock Exchange is a market where shares and securities are bought and sold by members/brokers on behalf of their clients and also on their accounts.
    In Pakistan
    Karachi Stock Exchange
    Lahore Stock Exchange
    Islamabad Stock Exchange
    MaroofHussainSabri
    8
  • 9. Reason for Seeking a Stock Market Listing
    Reasons:
    Access to a wider pool of finance
    Improved marketability of shares
    Transfer of capital to other uses
    Enhancement of the company image
    Facilitation of growth by acquisition
    (Continued…)
    Maroof Hussain Sabri
    9
  • 10. Reason for Seeking a Stock Market Listing
    From Private Co. to “plc” (public company)
    Owner must accept the change-Significant loss of control to a wider circle of investors.
    The risk of the company being taken over will also increase following listing.
    To issue shares on a stock exchange, company has to obtain:
    Admission to listing from the financial services authority (SECP in Pakistan)
    Admission to trading from the Stock Exchange (KSE, LSE or ISE)
    Maroof Hussain Sabri
    10
  • 11. Ordinary Shares
    Issued to the owner of the company
    Have a nominal or face value, typically of £1 or 50p in UK, Rs. 10 in Pakistan
    No relationship between market value and nominal value of shares except when ordinary shares are issued for cash then it must be equal to or above the face value.
    Deferred Ordinary Shares: entitle to dividend only after a certain date or only if the profits rise above a certain amount
    Maroof Hussain Sabri
    11
  • 12. Circumstances for A New Issue of Shares
    To Wholly raise more cash & it can be:
    Right issue : Selling of new shares to existing shareholders in proportion to their existing shareholding
    Selling of shares to new shareholders:
    Number of new shares is small and the ownership of the company is minimally affected
    To partly raise cash but more importantly to float its shares on a stock market
    Issue new shares to the shareholder of another company, in order to take the company over.
    Maroof Hussain Sabri
    12
  • 13. Issues of Shares
    What is issue?Shares offered for sale
    Shares can be issued on London Stock Exchange y means of:
    Offer for Sale
    A Placing
    A Prospectus issue
    A stock exchange introduction
    Maroof Hussain Sabri
    13
  • 14. Offers for Sale
    Selling of shares to the public at large
    When company go public for the first time, a large issue probably take the form of an offer for sale.
    The issue price and offers for Sale:
    The offer price must be advertised a short time in advance
    Share is prices are set at a low level
    to ensure success of issue
    Share price rises to a premium above its issue price soon after trading begins. 20% above the price target premium is typical
    (Continue…)
    Maroof Hussain Sabri
    14
  • 15. Offers for Sale
    Over priced issue – undersubscribedunderwriters to buy up the unsold shares
    Too much under priced – oversubscribedCompany will be able to raise required capital by issuing fewer shares
    Share price of an issue - usually based on P/E ratio
    (continued)
    Maroof Hussain Sabri
    15
  • 16. Offers for Sale by Tender
    Offers for Sale by Tender:
    Issue price reflects the value of the shares as reflected by market
    Minimum price will be fixed and tenders will be invited with the price higher than it.
    Shares will be allotted at the highest price at which they will be taken up, the striking price
    (Continued…)
    Maroof Hussain Sabri
    16
  • 17. Offers for Sale by Tender
    Less common than Offers for sale due to:
    It reflects badly on the issuing house’s ability to determine the prices
    Major influence will be of the tenders of the institutional investors
    Determination of prices to be by the public rather than the City experts.
    Uncertain about the amount of finance that will be raised
    Deterrence of potential investors – unwilling to decide the price.
    Might follow a general increase in share values.
    Striking price is likely to be higher than the issue price set by the issuing company itself.
    Maroof Hussain Sabri
    17
  • 18. A Placing
    A placing is an arrangement:
    Shares are not offered to the Public
    Sponsoring market maker arranges for the most of the issue to be bought by the small number of investors.
    Usually Instt. Investors like Pension Funds & Insurance Companies
    Placings are much cheaper
    Most of the shares will be unlikely to be available for trading after floatation because of Instt. Investors
    18
  • 19. Choice B/w AN Offer for Sale and A Placing
    Large Issue – Offer for Sale
    Small Issue – A Placing – A Small number of investors
    Maroof Hussain Sabri
    19
  • 20. A Prospectus Issue
    Company offers its own shares to General Public
    An issuing house or Merchant Bank – Agent not underwriter
    Risky and rare
    Used by well known companies making a large new issue having already a quotation on the stock exchange
    Maroof Hussain Sabri
    20
  • 21. A Stock Exchange Introduction
    No shares are made available to market, neither existing nor newly created shares; nevertheless the stock exchange grants a quotation
    Reasons:
    Greater marketability for the shares
    A known share valuation for inheritance tax purposes
    Easier access in the future to additional capital
    Maroof Hussain Sabri
    21
  • 22. Intermediaries Offer
    For the companies obtaining listing of their shares for the first time
    Intermediaries such as broker or investments banks apply on behalf of their clients
    Maroof Hussain Sabri
    22
  • 23. Underwriting
    Underwriters – Financial Institutions which agree to buy at the issue price which are not subscribed for by the general public
    Remove risk of under-subscribed issue but at a cost to company
    Alternative to underwriting – shares offered at deep discount – in future dividends payable will be much higher
    Bought deal –Investment bank buys whole issue at a small discount to market
    Maroof Hussain Sabri
    23
  • 24. Factors for Pricing Shares
    Are there similar companies already quoated?
    Current market conditions?
    Accuracy of forecast of company’s future trading prospects
    A price which gives immediate premium
    Achievable steady growth in share price over the time.
    24
  • 25. The Timing and Costs of new equity Issue
    When share prices are high – high confidence level of investor – able to invest in companies with the potential to growth
    Issuing shares at high price
    Reduced Numbers of shares to raise capital
    Reduce the dilution of earnings for existing shareholders
    Lower share prices – lower business confidence
    Maroof Hussain Sabri
    25
  • 26. The Timing and Costs of new equity Issue
    Typical costs include:
    Underwriting costs
    Stock market listing fee
    Fee of issuing house, solicitors, auditors & P.R. Consultants
    Printing & Distribution expense of Prospectus
    Advesrtising
    Maroof Hussain Sabri
    26
  • 27. Right Issues & Vendor Placings
    A right issue is an offer to existing shareholders enabling them to buy more shares, usually at a price lower than the current market price
    Proportional to shareholder’s existing holdings. E.g. a right issue on a one for four basis at 280p per share
    Advantages:
    Cheaper than offers for sale. No prospectus, less cost of underwriting
    More beneficial to existing shareholders
    Relative voting rights are unaffected
    Finance raised may be used to reduce gearing to book value
    Maroof Hussain Sabri
    27
  • 28. Deciding the Issue Price for Right Shares
    Offer price will be lower than the current market price – protection against price fall after announcement
    Offer price must be at or above the nominal value – Company law
    Variable Discount Size
    Low enough to secure the acceptance by shareholders – not too enough to dilute earnings per share
    Maroof Hussain Sabri
    28
  • 29. Deciding the Issue Price for Right Shares
    Break Even PointWhere dilution is zerowhere Right Price = Capital employed per share
    Dilution in EarningsDecreasing the earning per share due to increase in the number of shares.
    Capital Employed Per Share=Total capital / Paid up capital
    Maroof Hussain Sabri
    29
  • 30. Deciding the Issue Price for Right Shares
    Example
    Current Capital Structure:
    200,000 shares of Re. 1 each 200,000Retained Earnings 100,000Total Capital
    Current Market Price Rs. 1.80
    Proposal to raise funds Rs. 126,000 from a right issue
    Company can achieve a profit after tax of 20%
    Required:
    Calculate No. of Shares if right price is Rs.1.60, Rs. 1.50, Rs. 1.40, Rs. 1.20
    Calculate the dilution in Earning per share in each case.
    Maroof Hussain Sabri
    30
  • 31. Deciding the Issue Price for Right Shares
    Solution:
    Present earnings = 20% of 300,000 = 60,000EPS = 0.30Forecasted Earnings after issue = 20% of 426,000 = 85,200
    No. of new shares = 126,000/rights price
    EPS = 85,200/no. of shares
    Break Even Point , where 300,000/200,000 = 1.50 = Right Price
    (Continued…)
    Maroof Hussain Sabri
    31
  • 32. Deciding the Issue Price for Right Shares
    Maroof Hussain Sabri
    32
  • 33. The theoretical ex rights Price
    Price changes after the announcement of right issue
    Market Price will fall – Uncertainty w.r.t dividend, future profits & earnings
    Duration depend on no. of shareholders & size of the holdings
    Price will recover after this fall, recovery value
    Cum Rights – Shares with rights attached
    Ex-rights – Shares without rights attached.
    New market price will be the consequence of adjustment to allow for the discount price of the new issue
    Maroof Hussain Sabri
    33
  • 34. The theoretical ex rights Price
    Example: Fundraiser plc
    Ordinary Shares of 1,000,000 of £ 1
    Market Price on Sep 1 = £2.10 per share
    Right issue offered at one for four shares at £ 1.50 per right
    Price Fall to £1.95 and recovered to £2 (Cum rights price)
    Calculate TERP?
    (Continued)
    Maroof Hussain Sabri
    34
  • 35. The theoretical ex rights Price
    TERP can be calculated by using formula :-
    Where
    N=No. of shares required to buy one new share
    Cum Right price will be the price till rights issue
    Issue price is Price of Right issue as offered
    Maroof Hussain Sabri
    35
  • 36. The theoretical ex rights Price
    Using formula:
    N=4, Cumrights price 2, Issue price = 1.50
    Putting in the formula, TERP = £1.90
    Alternative Method
    Value of portfolio for a shareholder of 4 shares before the rights issue:
    4 shares at £2.00 £8.001 share at £1.50 £1.50
    £9.50
    Value per share after right issue (TERP) is 90.5/5=1.90
    Maroof Hussain Sabri
    36
  • 37. The Value of Rights
    The value of rights is the theoretical gain a shareholder would make by exercising his rights
    If offered price in the rights issue 1.50 and expected market price after issue (TERP) is 1.90, 0.40 gain for each new share he will buy
    If cannot buy, sell the right to new subscriber. New subscriber will pay 1.50 for each share + 0.40 to the right holder
    Value of rights attached to each share = gain/N = 0.4/4 = 0.1 or 1p
    Maroof Hussain Sabri
    37
  • 38. Theoretical Gain or Loss to Shareholders
    Investor can take following courses of action:
    Take up or exercise the rights – Maintain their %age holdings in company
    To renounce the rights and sell them on the market – Low %age holdings of the company’s equity & total value of shares will be less
    To renounce part of rights & take up the remainder – total market value of shareholding remaining the same
    To do nothing – Company will sell to new subscribers as per stock exchange rules for the benefit of shareholders entitled to rights
    Maroof Hussain Sabri
    38
  • 39. Theoretical Gain or Loss to Shareholders
    EXAMPLE: Gopher plc
    Golper plc has issued 3,000,000 ordinary shares of £1 each, which are at present selling for £4 per share. The company plans to issue rights to purchase one new equity share at a price of £3.20 for every three shares held. A shareholder who owns 900 shares thinks that he will suffer a loss in his personal wealth because the new shares are being offered at a market price lower than market value. On the assumption that the actual market value of shares will equal to the TERP, what would be the effect on the shareholders wealth if:
    He sells all the rights
    He exercises half of the rights and sells the other half
    He does nothing at all
    Maroof Hussain Sabri
    39
  • 40. Theoretical Gain or Loss to Shareholders
    Solution
    TERP = £3.80Value of rights per new share = 3.80-3.20 =0.60Value of Rights attached to each existing share = 0.60/3 = 0.20
    These values are calculated using formulae previously given
    (Continued…)
    Maroof Hussain Sabri
    40
  • 41. Theoretical Gain or Loss to Shareholders
    If he sells all his rights:
    Sale Value of rights = 0.20 x 900 = 180
    Market Value of his 900 shares, ex rights = 900 x 3.80 = 3,420
    Total wealth = 180 + 3420 = 3,600
    No gain no loss but shareholding proportion in company will be lower
    (Continued..)
    Maroof Hussain Sabri
    41
  • 42. Theoretical Gain or Loss to Shareholders
    If exercise half of the rights and sells the other half:
    Sale Value of rights = 900/2 x 0.20 = 90
    Market Value of his shares = (900+450/3) x 3.80 = 3990
    Total = 90+3990=4080
    Additional Investment = 4080 – 3600 = 480
    No Gain No loss, increased investment in company by 480
    Maroof Hussain Sabri
    42
  • 43. Theoretical Gain or Loss to Shareholders
    If he does nothing,
    Market value of 900 shares cum rights = 3600
    Market Value of 900 shares ex right = 3420
    Loss in wealth = 180
    To protect his invesment he must exercise his rights or sell them. If not Company will may sell new securities to others to safeguard his benefit
    Maroof Hussain Sabri
    43
  • 44. The Actual Market Price After Right Issues
    The actual market price may differ from TERP.
    When
    Expected yield from new funds raised ≠ Earning yields from existing fund
    Decision to take up the offer will depend on:
    Expected rate of return on the investment
    The return obtainable from other investments
    Maroof Hussain Sabri
    44
  • 45. Example: Right Issues
    Example
    Musk plc has 4,000,000 ordinary shares in issue, valued at $ 2 each, and the company has actual earnings equal to 20% of the market value of the shares. A one for four rights issue is proposed, at an issue price of $ 1.50. If the market continue to value the shares on P/E ratio of 5, what would be the value per share if the new funds are expected to earn, as a percentage of the money raised :
    15%?
    20%
    25%
    How do these values in 1,2,3 compare with TERP? Ignore issue costs.
    Maroof Hussain Sabri
    45
  • 46. Example: Right Issues
    Solution
    TERP = $ 1.90
    New funds raised = 1.50 x 1,000,000 = 1,500,000
    (Note: 1,000,000 for 4,000,000 shares)
    P/E ratio is 5
    (Note P/E ratio multiplied with earnings will give price of shares, market price)
    (Continued…)
    Maroof Hussain Sabri
    46
  • 47. Example: Right Issues
    Earnings will be as follows:
    Additional earning (15% of 1,500,000)
    Current earnings (8,000,000 x 0.2)
    (Continue)
    Maroof Hussain Sabri
    47
  • 48. Example: Right Issues
    P/E ratio is 5, Market value will be Total earnings x 5
    T. Earnings x P/E = Market Value of Shares
    Price per share = Total Market value/No. of shares
    Maroof Hussain Sabri
    48
  • 49. The Actual Market Price After Right Issues
    Earnings with the Same Rate:TERP = Actual Market Value
    At a lower rate:TERP > AMV (Loss to shareholder)
    At a higher rateAMV > TERP (Profit to shareholder)
    Maroof Hussain Sabri
    49
  • 50. Vendor Placing
    A vendor placing occurs when there is an issue of shares by one company to take over another
    The shares are then sold in a placing to raise cash
    This cash will be used to pay to the shareholders in the target company who are selling their shares in the take over
    Maroof Hussain Sabri
    50
  • 51. Other instances of issuing shares
    Open Offer:
    Offer to existing shareholders, but different from right shares:
    Not necessarily pro-rata to existing shareholding
    Offer is not allotted renounceable documents
    Capitalization Issue
    Scrip issue
    Does not raise funds
    Capitalize reserves of the company – New shares to shareholders at a pro-rata to existing shareholding
    Maroof Hussain Sabri
    51
  • 52. Other instances of issuing shares
    Vendor Consideration Issue
    Issue of shares in a take over or merger
    For example, A plc wishes to take over B plc, a paper offer from A plc to shareholders of B plc to subscribe for newly issued shares of A plc.
    Very common due to mergers and takeovers nowadays
    Employees Share Options
    Offer to the employees to subscribe for shares at or below the market price.
    Maroof Hussain Sabri
    52
  • 53. Scrip Dividends, Scrip Issues & Stock Splits
    Not methods of raising funds:
    Alter the capital structure of Company
    Increase the Share Capital of Company
    A way of increasing no. of shares without raising funds
    Scrip Dividend Schemes Involve shareholders being issued shares in lieu of a cash dividend
    Maroof Hussain Sabri
    53
  • 54. Scrip Dividends, Scrip Issues & Stock Splits
    Scrip Dividend:
    Takes the form of new shares instead of cash. Converts Profit & Loss reserves into capital
    Optional for shareholder to take cash or bonus dividend.
    Scrip issue: Issue of bonus shares issued, also called bonus issue. Convert equity reserves into share capital
    Stock Split: Ordinary share is split into two shares to increase its marketability. Leaves reserves unaffected
    Maroof Hussain Sabri
    54
  • 55. Preference Shares
    Preference shares carry priority over ordinary equity shares with regard to dividend payments.
    Fixed percentage dividend
    Have no Voting rights
    Attractive for corporate investors.
    Tax Treatment:
    Dividend received are not subject to corporation tax
    Dividend Payments are not tax-deductible for the issuing company
    Maroof Hussain Sabri
    55
  • 56. Preference shares
    Positive Features:
    No dividend in the years where profits are poor
    Avoid dilution of control of existing shareholders
    Lower the company’s gearing (Unless redeemable which are treated as debt)
    Doesn’t restrict company’s borrowing power (as this capital is not secured by fixed assets)
    In case of non payment of dividend, shareholders cannot appoint receiver (as in Debentures)
    Negative features:
    Dividend payments on P.S. are not tax deductible
    To attract investors, level of payments should be higher than the interest yields on loan
    Maroof Hussain Sabri
    56
  • 57. Stock Market Ratios
    Indicators that can be used to asses investors returns
    The dividend yield
    Earning Per Share (EPS)
    Price to Earning ratio (P/E ratio)
    Dividend Cover
    Dividend Pay out ratio
    Maroof Hussain Sabri
    57
  • 58. The Dividend Yield & the Interest Yield
    Dividend Yield
    Dividend Yield = Gross dividend per share/market price per share x 100
    Gross dividend include Dividend paid + appropriate tax credit (normally for preference shares) so that a direct comparison with interest yield can be made
    Interest Yield
    Interest Yield = Gross interest/Market Value of Loan stock x 100
    It may be different from coupon rate
    It is investors rate of return
    Maroof Hussain Sabri
    58
  • 59. The Dividend Yield & the Interest Yield
    Normally dividend yield on shares of quoted companies is lower than Interest yield on debentures & loan stock, however share holders get benefit as follows due to which there return exceeds interest yield:
    Dividend in the long run
    Capital Gain
    Both these contribute a greater return then from fixed interest securities
    Maroof Hussain Sabri
    59
  • 60. The Dividend Yield & the Interest Yield
    Example: A company pays a dividend of 15p(net) per share. The Market Price is 240p. What will be the dividend yield if the rat e of tax credit is 10%?
    Solution:
    Gross dividend per share=15x100/(100-10)=16.67
    Dividend Yield = 16.67p/240p=6.95%
    Note: Gross Dividend per share(15p=100+(100-10)
    Maroof Hussain Sabri
    60
  • 61. The Dividend Yield & the Interest Yield
    Example: An investment buys $1,000(par value) of a bond with a coupon of 8% for the current market value of $750
    Interest Yield=(8%of1000)/750 x 100 = 10.67%
    Maroof Hussain Sabri
    61
  • 62. Earnings per Share
    EPS=Net Profit/No. of ordinary shares
    Widely used as a measure of a company’s performance
    Particularly important in comparing results over a period of several years
    Investors also look for growth in the EPS from one year to the next
    Maroof Hussain Sabri
    62
  • 63. EPS
    Example:ABC Ltd.Profit before tax = $9,320,000Tax amounted to $ 2,800,000
    Share Capital is as follows:Ordinary Shares (10,000,000 shares at $1) = 10,000,0008% preference shares=2,000,000
    Total 12,000,000
    Calculate EPS
    Solution:
    ABC Ltd.Profit before tax 9,320,000Less Tax 2,800,000P Profits after tax 6,520,000 Pref Dividend 160,000 Earnings 6,360,000
    No. of ordinary shares=10,000,000
    EPS = 63c
    Maroof Hussain Sabri
    63
  • 64. Price to Earnings Ratio
    Price to Earning ratio =
    Market price of share/Earning per share
    Or
    Total Market value of equity/Total earnings
    Example: A company has recently declared a dividend of 12p per share. The share price is £3.72 cum div & earnings for most recent year were 30p per share.
    P/E ratio = MV ex div/EPS = 3.60/30p = 12
    Maroof Hussain Sabri
    64
  • 65. Dividend Cover & Dividend Pay Out Ratio
    Dividend Cover = Max. possible dividend that could be paid out of current profits/Actual dividend for ordinary shares
    Dividend pay out ratio = DPS/EPS x 100
    or Div for the year/PAIT x 100
    Maroof Hussain Sabri
    65
  • 66. Dividend Cover & Dividend Pay Out Ratio
    Example: The EPS of York plc is 20p. The dividend was 20% on 25p ordinary shares.
    div cover = 20p/(20% of 25p) = 4
    Means co is retaining 75% for reinvestment purposes
    Div. payout ratio = 20% of 25p /20p x 100% =25%
    Maroof Hussain Sabri
    66