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Ch. 7 sec. 7.1 and 7.2 Gitman Principle of Managerial Finance

Differences Between Debt and Equity Capital

Capital: The long terms of funds, all items in on the right side of BS is capital (excluding CL)

Equity capital consists of long term funds provided by the firms owner, the stockholders Unlike creditors (lenders), holders of equity capital are owners of the firms Stockholder has a voice in management

Equity Capital

The claims of holders of equity is secondary to the claim of creditors Because equity holders are the last to receive any distribution of assets, they expect greater returns from dividends and /or increases in stock price

Claims on Income and Asset

Unlike debt, equity capital does not Mature so repayment is not required Permanent form of financing The price that can be realized may fluctuate Thus, makes the overall returns for stockholders more risky Interest payment: Tax-deductible; Dividend payment: not taxdeductible.

Maturity and Tax Treatment

Common and Prefered Stock

The true owner of business firm Residual owners; receive what is left. Expect to compensated with adequate dividends and capital gains

Common Stock

Privately owned Closely owned Publicly owned

Par Value: Relatively useless value. Preemptive Rights: allow common stockholders to maintain proportionate ownership Dilution of ownership

Common Stock (Cont)

Authorized Shares Outstanding Shares Treasury Stock Issued Shares

Common Stock (Cont)

Golden Enterprise Common Stock-$0.8 par value; authorized 35,000,000 shares; issued 15,000,000 shares.

Stockholders Equity Issued 15m shares Paid in capital in excess of par Retained Earning $12m $63m $31M $106m

Less: Cost of treasury shares (1m shares)



Total stockholders equity


Each share of common stock entitles its holder to one vote in the election of directors or special issue Supervoting shares Nonvoting common stock Proxy Statement Proxy Battle

Voting Rights

Most corporation pay dividends quarterly Dividends may be paid in cash, stock, or merchandise Historical dividend pattern


Preferred stockholders promised a fixed periodic dividend As percentage or as dollar amount

Par value preferred stock No-par value preferred stock

Preferred Stock

Restrictive Covenants
Focus on ensuring the firms continued existence and reguler dividends

Cumulative dividend paid before dividends paid to common stockholders

Retire outstanding stock at certain period and specific price

Conversion Feature

Feature of Preferred Stock

Fixed income Not normally given voting rights Preference in the liquidation of asset Moderate risk taker

Fluctuated Voting rights Behind preferred stockholder and creditors True risk taker

Basic Rights of Stockholders

Issuing Common Stock

Privately Raised external equity capital used to fund earlystage firms with attractive growth prospects Venture Capitalist Angel Capitalist (Angels)

Venture Capital

Sell stock in primary market:

Public Offering (IPO) Rights Offering Private Placement

Prospectus Investment bankers and company executive promote the stock by doing roadshow

Going Public

A formal legal document, which is required by and filed with the Securities and Exchange Commission, that provides details about an investment offering for sale to the public. A prospectus should contain the facts that an investor needs to make an informed investment decision. Also known as an "offer document". There are two types of prospectuses for stocks and bonds: preliminary and final. The preliminary prospectus is the first offering document provided by a securities issuer and includes most of the details of the business and transaction in question. Some lettering on the front cover is printed in red, which results in the use of the nickname "red herring" for this document. A passage in red states the company is not attempting to sell its shares before the registration is approved by the SEC. There is no price or issue size stated in the red herring.


The Red Herring is sometimes updated several times before being called the final prospectus. The final prospectus is printed after the deal has been made effective and can be offered for sale, and supersedes the preliminary prospectus. It contains such details as the exact number of shares/certificates issued and the precise offering price. In the case of mutual funds, which, apart from their initial share offering, continuously offer shares for sale to the public, the prospectus used is a final prospectus. A fund prospectus contains details on its objectives, investment strategies, risks, performance, distribution policy, fees and expenses, and fund management.

Prospectus (Cont.)

The investment banks represent the "sell side" (as they are mainly in the business of selling securities to investors), while mutual funds, advisors and others make up the "buy side". Underwriting: The process by which investment bankers raise investment capital from investors on behalf of corporations and governments that are issuing securities (both equity and debt). The word "underwriter" came from the practice of having each risk-taker write his or her name under the total amount of risk that he or she was willing to accept at a specified premium. In a way, this is still true today. New issues are usually brought to market by an underwriting syndicate in which each firm takes the responsibility (and risk) of selling its specific allotment.

Investment Banker Role

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