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LEARNING OBJECTIVES
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Explain the features of ordinary shares Focus on the benefits and valuation of rights shares Discuss the pros and cons of debentures and preference shares Highlight the features of term loans
INTRODUCTION
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Ordinary shares provide ownership rights to investors. Debentures or bonds provide loan capital to the company, and investors get the status of lenders. Loan capital is also directly available from the financial institutions to the companies.
Ordinary SharesFeatures
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Claim on Income Claim on Assets Right to Control Voting Rights Pre-Emptive Rights Limited Liability
Disadvantages
Cost Risk Earnings Dilution Ownership Dilution
Public issue of equity means raising of share capital directly from the public. As per the existing norms, a company with a track record is free to determine the issue price for its shares.
Underwriting of Issues
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It is legally obligatory to underwrite a public and a rights issue. In an underwriting, the underwritersgenerally banks, financial institution, brokers, etc. guarantee to buy the shares if the issue is not fully subscribed by the public. The agreement may provide for a firm buying by the underwriters. The company has to pay an underwriting commission to the underwriter for their services.
Private Placement
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Private placement involves sale of shares (or other securities) by the company to few selected investors, particularly the institutional investors. Private placement has the following advantages:
Size Cost Speed
Selling of Ordinary Shares to the existing shareholders of the company. Value of Right px ps r= n
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Advantages
1. Control is maintained 2. Less flotation cost 3. Issue more likely to be successful
Disadvantages
1. Shareholders lose if fail to exercise their right 2. If shareholding concentrated in hands of FI
Preference Shares
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Similarity to Debentures:
1. Dividend rate is fixed. 2. Do not share in residual earnings. 3. Preference shareholders have claims on income and assets prior to ordinary shareholders. 4. Usually do not have voting rights.
Preference SharesFeatures
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1. 2. 3. 4. 5. 6. 7. 8. 9.
Claims on Income and Assets Fixed Dividend Cumulative Dividend Redemption Sinking Fund Call Feature Participation Feature Voting Rights Convertibility
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Disadvantages:
Non-deductibility of Dividends Commitment to pay dividends
DEBENTURES
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A debenture is a long-term promissory note for raising loan capital. The firm promises to pay interest and principal as stipulated. The purchasers of debentures are called debenture holders. An alternative form of debenture in India is a bond. Mostly public sector companies in India issue bonds.
DebenturesFeatures
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Interest Rate Maturity Redemption Sinking Fund Buy-back (call) provisions Indenture Security Yield Claims on Assets and Income
Types of Debentures
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1. 2. 3.
Advantages:
Less Costly No ownership Dilution Fixed payment of interest Reduced real obligation
Disadvantages:
Obligatory Payment Financial Risk Cash outflows Restricted Covenants
Term LoansFeatures
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