4. Chapter Equity

1. The value of a company which is the property of its ordinary shareholders, or a company's capital which is invested by shareholders, who thus become owners of the company

2. Equity is the residual(Restwert) of recognized assets minus recognized liabilities. It may be subclassified into funds contributed by shareholders, retained earning and gains and losses recognized directly in equity.

• Ownership in a corporation is divided into shares of stock.

  • These shares carry rights to share in the profits of the firm through future dividend payments.

• The shares also come with rights to vote to elect directors and decide on other important matters.

  • Some firms issue preferred stock, which has preference over common stock in the payment of dividends and in liquidation, but typically carries no voting rights.

• The Valuation Principle states that the value of a stock is equal to the present value of the dividends and future sale price the investor will receive.

Yes it is .. as well:

• we have to calculate two KPI´s

  1. Expected return = r

2. the price = P”0”

• It is also driven by the price and the dividends but in a longer period of time. Therefore we have to disocunt.

  • Price on year hence formular:

General Stock price formular:

• The constant dividen growth model assumes that that dividens grow at constant expected rate = g

• If all increases in future earnings result exclusively from new investments made with retained earnings (money plowed back into the business),

• earnings growth can be found as retention rate multiplied by return on investment.

• The dividend-discount model is sensitive to the dividend growth rate, which is difficult to estimate accurately and it is not practical for valuing the majority of stocks not paying dividends or paying not many dividends

The dividend-discount model is

• sensitive to the dividend growth rate

• it is difficult to estimate accurately and

• it is not practical for valuing the majority of stocks not (yet) paying dividends.

If the firm undertakes share repurchases, it is more reliable to use the total payout model (present value of future total dividends and repurchases) to value the firm.

-> Payout ratio = total dividends/ net income

these formulae only work if the company has reached „steady state growth“.

1. Initial capital provided by the entrepreneur

2. Angel investor

3. Venture Capital Firm

4. private equity firm

5. institution investor

6. Strategic partnership

• Individual Investors who buy equity in small private firms

• A limited partnership that specializes in raising money

• invest in the private equity of young firms

• Organized very much like a venture capital firm

• it invests in the equity of existing privately held firms rather than start-up companies.

• can be:

  • pension funds

  • insurance companies

  • endowments

  • foundation

    • may invest directly in private firms

    • may invest indirectly by becoming limited partners in venture capital firms

• A corporation that invests in private companies

• Also known as corporate partner, strategic partner, and strategic investor

• might invest for corporate strategic objectives, in addition to the financial returns.

Through an initial public offering (IPO) is the first time a company sells its stock to the public.

• greater liquidity

• access to capital

• regulatory and financial reporting requirements

• undermining(untergraben) of the investors’ ability to monitor the company’s management

• transactions cost of IPO´s are very high

• shares are being sold to raise new capital

if the shares are sold by earlier investors

• An underwriter is an investment bank that manages the IPO process

• helps the company sell its stock

• The SEC requires that a company file a registration statement prior to an IPO.

• The preliminary prospectus is part of the registration statement that circulates to investors before the stock is offered.

• The bookbuilding process is a method of placing securities in which interested investors can bid for the purchase within a specified price range within a specified subscription period.

• Depending on demand from the investor side, the 'fair' issue price can thus be determined

• When a company decides to sell securities, it enlists the help of an investment bank to execute the sale.

• Both parties draw up a best efforts agreement that outlines the minimum amount of securities involved.

• Having an agreement lets securities issuers know exactly how much money they will raise once the offering is closed.

• In most cases, best effort agreements are used in less-than-ideal market conditions

• or when there is more risk involved, as is the case with an unseasoned offering

• A Dutch auction is a type of auction where securities are priced via bids rather than the seller setting the price.

• A Dutch auction is a means of selling securities where the seller sets an opening price, which decreases until bids are made, and it is most commonly used in IPOs.

• At the end of a Dutch auction, all securities are sold at the lowest accepted bid price.

• Dutch auctions democratize the IPO process, allowing individual investors to participate

• senior management and its underwriters travel around promoting the company

• They explaining their rationale for an offer price to the underwriters’ largest customers

• mainly institutional investors.

• These investors subsequently express their interest in the IPO by placing orders at various prices.

• On average, IPOs appear to be underpriced

• The price at the end of trading on the first day is often substantially higher than the IPO price.

• When times are good, the market is flooded with IPOs

• when times are bad, the number of IPOs dries up.

• The transaction costs of the IPO are very high, and it is unclear why firms willingly incur such high costs

• The long-run performance of a newly public company (three to five years from the date of issue) is poor.

• That is, on average, a three- to five-year buy-and-hold strategy appears to be a bad investment.

• A seasoned equity offering (SEO) is the sale of stock by a company that is already publicly traded.

• cash offer: when new shares are sold to investors at large

• rights offer: when new shares are offered only to existing shareholders

• The stock price reaction to an SEO is negative on average

• give shareholders a “fair” payment on their investment.

• Investors receive dividends in return for their investement

• As an alternative to dividend payments, the company can repurchase its own stock.

• Repurchases are used to return unwanted cash to shareholders or to retire equity and replace it with debt.

… a trade-off between cash dividends and the issue or repurchase of common stock.

1. try to avoid reducing the the dividends

2. try to maintain a smooth dividend stream

3. look at the current dividend level

• due to the self-discipline that comes from spending only dividend income rather than having to decide whether they should dip into capital

• investors often pressure companies to increase dividends when they do not trust management to spend free cash flow wisely.

• High dividends reflect managers’ views about a firm’s future earnings prospects (signaling hypothesis)

• a serious market imperfection (different tax treatment of dividends and capital gains) no longer exists in many tax jurisdictions

Young growth company:

• pay no cash dividends and rarely repurchase stock.

• These firms have profitable investment opportunities.

• They finance these investments as much as possible from internally generated cash flow.

• As firms mature, profitable investment opportunities shrink relative to cash flow. -

• The firm comes under pressure from investors, because investors worry that managers will overinvest if there is too much idle cash available.

• The threat of a lagging stock price pushes managers to distribute cash by repurchases or cash dividends

• Investors’ concern with payout decisions seems to stem mainly from the information that they read into managers’ actions.

• Committing to a regular cash dividend sends the more credible signal of financial discipline

1. retain free cash flow

   1. invest in new projects

   2. increase cash reserves

2. pay out

   1. repurchase shares

   2. pay dividends

• no it has no effect in an ideal world

• but people thinks that a high dividend payout enhances the share price

• high dividens maybe reflect the firm future earnings prospectus

The Capital Asset Pricing Model (CAPM) is the most common approach for estimating the cost of equity capital

• Beta

  • Estimate the firm’s beta of equity, typically by regressing 60 months of the company’s returns against 60 months of returns for a market proxy such as the S&P 500

• risk- free-rate

  • Determine the risk-free rate, typically by using the yield on Treasury bills or bonds.

• market risk premium

  • Estimate the market risk premium, typically by comparing historical returns on a market proxy to historical risk-free rates.

Cost of Equity = Risk Free Rate + Equity Beta * Market Risk Premium

Cost of equity= (DIV(in one year) / current price) + dividend growth rate

DGR= (DIV/P)+ g