8486470

Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Fundamentals of Corporate Finance 3e
Ross, Thompson, Christensen, Westerfield and Jordan
Slides prepared by Sue Wright
17-1
Chapter Seventeen
Issuing Securities to the Public

17-2
17.1 The Public Issue
17.2 The Cash Offer
17.3 New Equity Sales and the Value of the Firm
17.4 The Costs of Issuing Securities
17.5 Rights
17.6 Dilution
17.7 Issuing Long-term Debt
17.8 Summary and Conclusions
Chapter Organisation

17-3
Chapter Objectives
• Outline the advantages and disadvantages of public company
listing.
• Discuss the process of underwriting and the associated costs.
• Identify the costs associated with issuing securities.
• Explain the process of a rights issue and calculate the value of
a right.
• Discuss the dilution effect of new issues.
• Understand the reasons for recent growth in the corporate
debt market.

17-4
• Analyse funding needs and how they can be met.
• Approval from board of directors for a public issue.
• Outside expert opinions sought for support of
issue.
• Pricing, time-tabling, prospectus prepared,
marketing.
• Prospectus filed with ASIC and ASX.

17-5
• Underwriting agreement executed.
• Prospectus registered.
• Public announcement of offering.
• Funds received.
• Shares allotted, holdings registered.
• Shares listed for trading on ASX.

17-6
New Issues
• Flotation is the initial offering of securities to the
public.
• Primary issues used to:
– convert from a private company to a public company
– spin-off a portion of the business of a listed company
– form a new public company
– privatise a public organisation, or demutualise a mutual
society.

17-7
Advantages of Public Company
Listing
• Access to additional capital.
• Increased negotiability of capital.
• Growth not limited by cash resources.
• Enhancement of corporate image.
• Can attract and retain key personnel.
• Gain independence from a spin-off.

17-8
Disadvantages of Public Company
Listing
• Dilution of control of existing owners.
• Additional responsibilities of directors.
• Greater disclosure of information.
• Explicit costs.
• Insider trading implications.

17-9
Secondary Issues
• Private placements—securities are offered and sold to a
limited number of investors who are often the current major
investors in the business.
• Rights issues—issue of shares made to all existing
shareholders, who are entitled to take up the new shares in
proportion to their present holdings.
• Terms are determined by:
– amount of funds required by the company
– the market price of the company’s securities
– general economic conditions
– desire to benefit shareholders
– nature of the company’s shareholders.

17-10
Underwriting
• Firm underwriting
A guarantee that funds will be made available to a company
at a specific time on agreed terms and conditions.
• Standby underwriting
Where the bidding company has insufficient cash in a
successful bid or if cash is offered as an alternative to a share
bid.
• Best efforts underwriting
Underwriter must use ‘best efforts’ to sell the securities at the
agreed offering rate.

17-11
Underwriting
• Role of underwriter
– pricing the issue
– marketing the issue
– engaging sub-underwriters
– placing the shortfall
• Sub-underwriter
– A group of underwriters formed to reduce the risk and to
help to sell an issue.

17-12
Underwriting Fees
• The underwriter’s fee is a reflection of the:
– size of the issue
– issue price
– general market conditions
– market attitude towards shares
– time period required for underwriting.
• Fees also include brokerage and management fees.

17-13
Average Initial Returns
Annual sales of
issuing firm ($)
Number
of firms
Average
initial return (%)
0 386 42.9
1 – 999 999 678 31.4
1 000 000 – 4 999 999 353 14.3
5 000 000 –14 999 999 347 10.7
15 000 000 – 24 999 999 182 6.5
25 000 000 or larger 493 5.3
All 2 439 20.7
Source: Ibbotson, Sindelar and Ritter (1988)

17-14
New Equity Sales—Research
Findings
• Shares prices tend to decline after a new equity issue
announcement, but rise following a debt announcement.
• Why?
– Management has superior information about firm value
and knows when the firm is overvalued → sell equity.
– Excessive debt usage.
– Substantial issue costs.
– Management needs to understand the signals that an
equity issue sends.

17-15
The Cost of Issuing Securities
Underwriter’s commission This consists of direct fees paid by the issuer to the
underwriting syndicate.
Other direct expenses These are direct costs, incurred by the issuer, that are
not part of the compensation to underwriters. These
costs include filing fees, legal fees, and taxes—all
reported on the prospectus.
Indirect expenses These costs are not reported on the prospectus and
include the costs of management time spent working on
the new issue.
Abnormal returns In a seasoned issue of shares, the price drops on
average by 3 per cent upon the announcement of the
issue.
Underpricing For initial public offerings, losses arise from selling the
shares below the correct value.

17-16
Rights Offerings—Basic Concepts
• Rights offering
Issue of ordinary shares to existing shareholders.
• Allows current shareholders to avoid the dilution that can occur
with a new share issue.
• ‘Rights’ are given to the shareholders specifying:
– number of shares that can be purchased
– purchase price
– time frame.
• Shareholders can either exercise their rights or sell them. They
neither win nor lose either way.

17-17
Rights Offerings—Basic Concepts
• Subscription price
The dollar cost of one of the shares to be issued, generally
less than the current market price.
• Ex-rights date
Beginning of the period when shares are sold without a
recently declared right, normally four trading days before the
holder-of-record date. The share price will drop by the value
of the right.
• Holder-of-record date
Date on which existing shareholders are designated as the
recipients of share rights.

17-18
Ex-rights Share Prices
Rights-on Ex rights
Announcement
date date date
Ex-rights Record
30 September 13 October 15 October
Rights-on
price
$20.00
Ex-rights
price
$16.67
$3.33 =Value of a right

17-19
Theoretical Rights Price








r
n
S
M
n
offered
shares
additional
of
number
issue
rights
the
of
price
issue
or
on
subscripti
price
market
right
a
obtain
to
held
shares
of
number




r
S
M
n
Where:

17-20
Example—Rights Issue
Lemon Co. currently has 5 million shares on issue
with a market price of $8 each. To finance new
projects, the company needs to raise an additional
$6 million. To raise the finance, the company
makes a rights issue at a subscription price of $6
per share.

17-21
Example—Rights Issue (continued)
• The number of new shares to be sold:
• The holder of one right is entitled to subscribe to one new
share at $6 per share.
• To issue 1 million shares, the company would have to issue
1 million rights.
• The company has 5 million shares on issue, which means
that for every 5 shares held, a shareholder is entitled to
receive one right (1-for-5 rights issue).
shares
000
000
1
$6
000
000
$6
price
on
subscripti
raised
be
to
funds




17-22
Example—Rights Issue (continued)
• Calculate the theoretical rights price:
• If an outsider buys a right, it will cost $1.67.
• The right can be exercised at a subscription price of $6.
• Total cost of a new share = $1.67 + $6 = $7.67.
$1.67
1
5
$6
$8
5



















r
n
S
M
n

17-23
The Value of Rights
Initial position No. of shares 5 million
Share price $8
Value of firm $40 million
Terms of offer Subscription price $6
No. new shares issued 1 million
After issue No. of shares 6 million
Value of firm $46 million
Share price $7.67
Value of right per share $0.33*
Value of a right $1.65**
*$8.00 – 7.67 = 0.33
**$0.33 × 5 = $1.65

17-24
New Issues and Dilution
• Dilution
– Loss in existing shareholders’ value in terms of either
ownership, market value, book value or EPS.
• Types of dilution
– Dilution of proportionate ownership—a shareholder’s
reduction in proportionate ownership due to less-than-
proportionate purchase of new shares.
– Dilution of market value—loss in share value due to use
of proceeds to invest in negative NPV projects.
– Dilution of book value and earnings per share (EPS) —
reduction in EPS due to sale of additional shares. This
has no economic consequences.

17-25
Corporate Debt
The late 1980s saw a major growth in the Australian
corporate debt market due to:
– the substantial cutback in the level of government
borrowing
– the fall in interest rates from extremely high levels
– the flight to quality
– the shortage of government bonds
– the attractiveness of raising funds in the domestic market
relative to that of the euromarket.

17-26
Long-term Debt
Differences between direct, private long-term financing and
public issues of debt include:
– direct loans avoid ASIC registration costs
– direct loans have more restrictive covenants
– term loans and private placements are easier to
renegotiate than public issues
– private placements are dominated by life insurance
companies and pension funds, whereas commercial
banks dominate the term-loan market.

8486470

Recommended

Recommended

More Related Content

What's hot

What's hot (13)

Similar to 8486470

Similar to 8486470 (20)

Recently uploaded

Recently uploaded (20)

8486470