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Sources of long term funds Equity Shares Preference Share Debenture Retained Earnings Term Loan Right Issue
Equity sharesFeatures of equity shares1.Right to income : The equity investors have residualclaim to the income of company. The incomeleft after satisfying the claims of all otherinvestors belongs to equity shareholder. Thisincome is simply equal to profit after tax minuspreference shares dividend. The income of equityshareholders may be retained by the firm or paidout as dividends. Equity earnings which are retained infirm tend to increase market value of equityshares & earnings distributed as dividend providecurrent income to equity shareholders.
2. Right to control Equity shareholders are owners of thefirm. So they can elect the board ofdirectors & have right to vote on everyresolution passed before the company. Theboard of directors selects the management& management controls the operations offirm. Hence, equity shareholders indirectlycontrol the operation of firm.
3.Pre-emptive right The pre- emptive right enables existingshareholders to maintain their proportionalownership by purchasing the additional equityshares issued by company. According to law,existing shareholders have first priority topurchase additional shares on pro rata basisbefore the others. Ex. if company has10,00,000 outstanding shares of equity &proposes to issue 3,00,000 additional equityshares, an equity shareholder owing 100shares has the first right to purchase 30 of3,00,000 new shares before those are offeredto anyone else
4.Right in liquidation Equity shareholders have a residualclaim over the assts of the firm in the eventof liquidation. Claims of all others-debenture holders, secured lenders,unsecured lenders, other creditors, &preference shareholders – are prior to theclaim of equity shareholders.
Evaluation Evaluations from the view point of Company: Advantages :1. Permanent capital : it represents permanent capital. Hence there is no liability for repayment.2. No obligation to pay dividend : equity shares impose no obligation on the company to pay a fixed dividend to the equity shareholders. They get dividend if adequate profits are available.3. No charge on property : the company is able to procure capital without creating charges on its property, which remain free & can be utilized when additional funds are required by the company.
4.Wide scope of marketability : equity shares are lower denominations, hence they can be purchased by persons of limited income also. So there is a wide scope of marketability of equity shares.5.High creditworthiness : The equity capital increases the company’s financial base & thus it’s borrowing limit increase. Lenders generally lend in proportion to the company’s equity capital. By issuing Equity shares, the company increases its financial capability. It can borrow when it needs additional funds.6.High premium : the company can easily sell equity shares on premium in times of boom. Even in such circumstances , people are most eager to buy equity shares. Hence company can easily & quickly raise fixed capital through equity shares.
Disadvantages1. Cost of equity : cost of equity is generally highest. The rate of return required by equity shareholders is generally higher than rate of return required by other investors.2. Floatation cost : floatation cost means cost of issuing equity shares, which is higher than cost of issuing other types of securities. Underwriting commission , brokerage costs & other issue expenses are higher for equity capital.3. Interference in management : equity shareholders have voting rights. Hence there may be interference in existing pattern of management.
4. Speculation : there are the higher chances of speculation because it is traded in stock market.5. Dividend is not tax deductible : equity share dividend is not tax deductible payment6. Dilution of control : Sale of Equity shares to outsiders may result in dilution of control of existing shareholders
Evaluations from the view point of Shareholders: Advantages 1.Higher Dividend : The equity shareholders earn more by way of dividend compared to other alternatives during prosperous time. 2.Voting Right : Equity shares holders have a voting right. Shareholders can participate in the Management of company through voting right. They can vote for many important matters such as election of director& auditor, approval of dividend recommended by director.
3.Capital Appreciation : Equity shareholders get the benefit of capital appreciation, when boom condition prevail.4.Right Shares : An Existing company has to offer the new issue of its shares to existing shareholders as right shares on priority basis.5.Good Liquidity Position : The liquidity position of Equity shareholders is improved because these shares are freely traded in all national level stock exchanges.
Disadvantages1.Uncertain Return : no fixed rate of dividend is to be paid to equity shareholders. Only directors have the authority to decide whether to declare dividend or not.2.Residual Claim On Income As Well As Assets : equity shareholders have last priority on income as well as assets after satisfying claims of others-- debenture holders, secured lenders, unsecured lenders, other creditors, & preference shareholders.3.Low Market Value : when low dividends are declared or postpone the dividend , the market value of equity shares decline & investors suffer a capital loss.
4.Risky Investment : equity prices tend to fluctuate widely, so making equity investment risky.5.Higher Speculation : During boom phase of stock market, Equity shares may encourage too much speculation.6.Dilution of Control : The issue of new Equity shares may dilute the ownership & control of existing shareholders while a preemptive right to retain their proportionate ownership; they may not have funds to invest in additional shares.
Important terms• Authorized, issued, subscribed & paid-up capital : the amount of capital that a company can potentially issue, as per its memorandum, represents the authorized capital. The amount offered by company to investors is called issued capital. The part of issued capital issued capital which has been subscribed by investors represents subscribed capital. The actual amount paid up by investors is called paid –up capital.
• Per value, Issue price, Book value & Market value : The per value of equity share is the value stated in the memorandum & written on share scrip. It is also called as face value. It is generally Rs. 10 or rs.100. infrequently, par value like re.1, Rs. 2, Rs.5 , Rs. 50 are available.• The issue price is the price at which equity share is issued. When issue price exceeds par value, difference is referred to as the share premium.
• The book value of equity share = Paid up equity capital + reserve & surplus No. of outstanding equity shares• The market value is the price at which it is traded in the stock market.