Common and Preferred Stock C H A P T E R S E V E N T E E N Financing Limited 2000
Figure 17-1 Time line during rights offering PPT 17-1 Limited 2000
Beforetax and aftertax yields on corporate debentures and preferred shares Beforetax debenture yield............. 5.34 percent Federal tax (29%)................... (1.55) Provincial tax (44% of federal tax)..... (0.68) Aftertax debenture yield.............. 3.11 percent PPT 17-2 Beforetax preferred yield.............. 4.50 percent Gross up (25%)...................... 5.63 Federal tax (29% of grossed-up amount). 1.63 Tax credit (13 1/3% of grossed-up amount).75 Net federal tax....................... (0.88) Provincial tax (44% of federal tax)...... (0.39) Aftertax preferred yield................ 3.23 percent Limited 2000
Table 17-1a Features of alternative security issues PPT17-3 1. Ownership and control of the firm Common Stock Belongs to common shareholders through voting rights and residual claim to income Preferred Stock Limited rights when dividends are missed Bonds Limited rights under default in interest payments 2. Obligation to provide return None Must receive payment before common shareholder Contractual obligation 3. Claim to assets in bankruptcy Lowest claim of any security holder Bondholders and creditors must be satisfied first Highest claim 4. Cost of distribution Highest Moderate Lowest Limited 2000
Table 17-1b Features of alternative security issues PPT17-3 5. Risk-return trade-off Common Stock Highest risk, highest return (at least in theory) Preferred Stock Moderate risk, moderate return Bonds Lowest risk, moderate return 6. Tax status of payment by corporation Not deductible Not deductible Tax deductible Cost = Interest payment (1 Tax rate) 7. Tax status of payment to recipient Dividend to another corporation is usually tax exempt Special tax treatment with dividend tax credit Same as common stock Interest usually fully taxable Limited 2000
Figure 17-2 Risk and expected return for various security classes PPT17-4 Required rate of return Corporate issues Common stock Subordinated debentures Senior unsecured debt Secured debt Long-term government securities Treasury bills (short term) Preferred stock Savings account Risk to investor Limited 2000
Chapter 17 - Outline LT 17-1 Common Stock The Voting Right Rights Offering Rights-on and Ex-rights Poison Pill Preferred Stock Provisions Associated with Preferred Stock Limited 2000
Common Stock LT 17-2 Common shareholders own the corporation and have ultimate control They have a residual (leftover) claim to all corporate income that is not paid out to others Common shareholders have the right to vote on all major issues, including election of the board of directors Practically, management controls the corporation on a daily basis is most sensitive to the holders of large blocks of shares, such as the founding family, mutual funds, pension funds, insurance companies, trust companies Limited 2000
The Voting Right LT 17-3 Proxy: a right to vote given to someone else s (absent shareholder s) vote Majority Voting: all directors must be elected by at least 51% of the vote doesn t allow minority shareholders representation on the board of directors Cumulative Voting: a shareholder s votes can all be used to elect 1 person allows minority shareholders representation on board Limited 2000
Rights Offering LT 17-4 Rights Offering: gives current shareholders a first option to purchase new shares (called a preemptive right provision) allows existing shareholders the same amount of control they have initially shareholder receives 1 right for each share of stock owned Limited 2000
Rights-on and Ex-rights LT 17-5 Rights-on if you buy the stock, you will also acquire a right toward a future purchase of the stock occurs when a rights offering is initially announced Ex-rights when you buy the stock you no longer get a right toward future purchase of the stock occurs after a certain period of time Limited 2000
Poison Pill LT 17-6 Poison Pill: a rights offering made to existing shareholders of a company in order to make it more difficult for another company to acquire it allows existing shareholders the right to buy additional shares of the stock at a very low price makes hostile takeovers very expensive and unattractive often introduced by management to protect their own interests Limited 2000
Preferred Stock LT 17-7 Preferred Stock: a hybrid security combining characteristics of both debt and common stock has a fixed dividend that must be paid before dividends on common stock dividends are not tax deductible to a company provides the company with a balance in its capital structure primary purchasers are corporate investors, insurance companies, and pension funds Limited 2000
Provisions Associated with Preferred Stock LT 17-8 Cumulative Dividends: if not paid in one year, dividends accumulate and must be paid in total before common shareholders Conversion Feature: preferred stock may be converted into common stock at the option of the holder Call Feature: company has option to redeem stock Retractable Feature: investor has option to redeem stock Floating Rate Dividend: company adjusts dividend to market conditions Limited 2000