ACCA AFM Syllabus B. Advanced Investment Appraisal - Long term finance - Notes ^{2 / 19}

These are:

1. Finance Lease

   You will notice we have included finance leases as potential sources of finance - don’t forget too to mention the possibility of selling your assets and leasing them back as a way of getting cash.

   Be careful though - make sure there are enough assets on the SFP to actually do this - or your recommendation may look a little silly ;)

2. Bank loans and bonds/debentures

   Bonds securities which can be traded in the capital markets.

   Bond holders are lenders of debt finance.

   Bond holders will be paid a fixed return known as the coupon.

   Traded bonds raise cash which must be repaid usually between 5 and 15 years after issue. 

   Bonds are usually secured on non-current assets thus reducing risk to the lender. 

   Interest paid on the bonds is tax-deductible, thus reducing the cost of debt to the issuing company.

   A rise in the corporate tax rate could lead a company could raise the proportion of debt in its capital structure, as this interest is tax deductible.

   The types of bonds issued by a company are Bond with warrants attached, Redeemable bond, Convertible bond.

3. Equity

   via a placing - does not need to be redeemed, since ordinary shares are truly permanent finance. 

   The return to shareholders in the form of dividends depends on the dividend decision made by the directors of a company, and so these returns can increase, decrease or be passed. 

   Dividends are not tax-deductible like interest payments, and so equity finance is not tax-efficient like debt finance.

4. Preference Share

   These are seen as a form of debt

5. Venture Capital

   For companies with high growth and returns potential

   This is provided to early/start up companies with high-potential. 

   The venture capitalist makes money by taking an equity share and then realising this in an IPO (Initial Public Offering) or trade sale of the company

6. Business angels

   are wealthy individuals who invest in start-up and growth businesses in return for an equity stake. 

   These individuals are prepared to take high risks in the hope of high returns.

7. Private equity

   consists of equity securities in companies that are not publicly traded on a stock exchange.

   Private equity funds might require a 20 – 30% shareholding or/and Rights to appoint directors

Rights Issue

For existing shareholders initially - means no dilution of control

• A 1 for 2 at $4 (MV $6) right issue means….

  The current shareholders are being offered 1 share for $4, for every 2 they already own. 

  (The market value of those they already own are currently $6)

Calculation of TERP (Theoretical ex- rights price)

• Calculation of TERP (Theoretical ex- rights price) 

  The current shareholders will, after the rights issue, hold:
  1 @ $4 = $4
  2 @ $6 =$12

  So, they now own a total of 3 for a total of $16. So the TERP is $16/3 = $5.33

Effect on EPS

Obviously this will fall as there are now more shares in issue than before, and the company has not received full MV for them

• To calculate the exact effect simply multiply the current EPS by the TERP / Market value before the rights issue

  Eg Using the above illustration
  EPS x 5.33 / 6

Effect on shareholders wealth

• There is no effect on shareholders wealth after a rights issue. 

  This is because, although the share price has fallen, they have proportionately more shares

  Equity issues such as a rights issue do not require security and involve no loss of control for the shareholders who take up the right

Methods of obtaining a listing

An unquoted company can obtain a listing on the stock market by means of a:

1. Initial public offer (IPO)

   When a company issues shares to the public for the first time. 

   They are often issued by smaller, younger companies looking to expand, or large private companies wanting to become public.

   For the individual investor it is tough to predict share prices on the initial day of trading as there’s little past data about the company often, so it’s a risky purchase.

   Also expansion brings uncertainty in any case

2. Placing

   Is an arrangement whereby the shares are not all offered to the public. 

   Instead, the shares are bought by a small number of investors, usually institutional investors (such as pension funds and insurance companies). 

   This means low cost - so good for small issues

   Placings are likely to be quick.

3. Public Issues

   These are underwritten & advertised. 

   This means they are expensive - so good for large issue