Summary - Business Finance - ثاني ثانوي

SUMMARY Fahd must evaluate multiple alternatives to develop a funding strategy for his company. Stock represents ownership (equity) in a corporation. Common stockholders are the residual owners and have the final claim on a corporation's earnings and assets after the company's obligations to creditors and preferred stockholders have been met. Common stockholders have the right to vote their shares and elect the company's board of directors. Once a corporation has generated earnings, the earnings are either distributed or retained. The retention of earnings is an important source of funds for corporations and increases the stockholders' investment in the company. Retained earnings may be used to finance future growth or to retire existing debt. Many corporations distribute a part of their earings as cash dividends. Some corporations pay share dividends, which increase the number of shares but do not decrease the company's assets. Stock splits alter the number of outstanding shares and, like share dividends, do not affect the company's assets, liabilities, or earning capacity. Stock splits and share dividends affect the price of the stock in proportion to the number of shares Issued. Corporations can elect to repurchase shares as an alternative to distributing cash dividends. If current stockholders want to retain their ownership in the company, they may choose not to sell their stock. On the other hand, preferred stock is more like bonds than common stock. As preferred stock. 1. pays a fixed dividend that may accumulate if it is not paid; 2. Is perpetual, in which case the company never has to retire it; and 3. may be callable. Other Issues including bonds, however, have mandatory repayment of the principal at a specified date. The dividends paid to preferred stockholders are distributions from earnings. Unlike interest payments to bondholders, preferred dividends are not tax-deductible expenses. The lack of tax deductibility reduces the attractiveness of preferred stock to issuers. Since preferred stock pays a fixed dividend. Its valuation is the same as a bond. Higher interest rates cause the prices of preferred stocks to fall, but lower interest rates cause their prices to rise. Analysis of a preferred stock is based upon the company's ability to cover (that is, pay) the dividend. A corporation may Issue a variety of bonds, ranging from secured mortgage bonds. The terms of each bond issue include the coupon rate of interest and the maturity date. The risks associated with Investing in bonds include defaulting on interest and principal repayments, increased interest rates that decrease the current market value of the bond, and the loss of purchasing power through odation. Bonds may also be callable, which permits the issuer to pay off the entire وزارة التعلم CHAPTER 7 Stocks and Bands 303

P304 Business Finance Issue prior to maturity. If interest rates rise and cause a bond's price to fall, it would be more advantageous for the issuer to repurchase the bonds than to call and retire them at par. Governments, as well as corporations, issue bonds. The general features and risks associated with Investing in government bonds are the same as with corporate bonds. The rate of return on government securities is dependent upon the perceived risk of the bonds, including the debt-to-GDP ratio. PROBLEMS 1. Describe the features of common stock. 2. Explain the impact of retaining earnings versus paying cash dividends on a corporation's balance sheet. 3. Identify the important dates for the distribution of a cash dividend. 4. Compare the impact of a cash dividend, stock dividend, and stock split on a company's balance sheet.

5. List the features of preferred stock. 6. Describe the general characteristics of bonds 7. Explain the relationship between changes in interest rates and the price of preferred stocks and bonds. 8. List the types of corporate bonds. 9. Explain how a country's debt-to-GDP ratio could influence the borrowing costs for the country. 10. The Saudi Construction Corporation (SCC) wants to issue new bonds. SCC's credit rating has changed from AA to AA+ How will this impact the expected return by investors for this new bond issue? وزارة التعليم CHAPTER 7 Stocks and Bonds 305

M 306Business Finance EXERCISES 1. Saudi Construction Corporation (SCC) eams SAR 9 per share, sells for SAR 90, and pays a SAR 6 per share dividend SCC has the following balance sheet: Balance Sheet Assets Liabilities and Equity Debt Owner's Equity Share Capital Retained Earnings Start of Year 150 a. What is the amount of share capital for SCC? b. What is the payout ratio for SCC? 60 X 40 150 c. The stock is split two for one. What will be the new price of the stock? d. What will be the price of SCC's stock when dividends are paid? e. Next year, SCC plans to use all of its annual profits to pay cash dividends. How will this change retained earning?

2. Saudi Construction Corporation (SCC) has issued a SAR 1,000 fixed rate bond paying 3.5% when the inflation rate is 2.5% It inflation rises to 3.5%, what is the discount an investor would be willing to pay for the fixed rate bond to maintain a 1% post-inflation retur? 3. Why might SCC consider issuing bonds instead of preferred stock? ASSESSMENT QUESTIONS Choose the correct answer 1. The owners of a corporation elect the board of directors. True/False 2. Which of the following is equity: 1. investments, 2 additional paid-in capital. 3. retained earnings? a. 1 and 2 b. 1 and 3 c. 2 and 3: d. 1, 2, and 3 3. A cash dividend reduces the firm's ability to increase assets. True/False 4. Financial transaction costs are costs involved in buying or selling in financial transactions. True/False 5. Stock repurchases: a. increase per share earnings. b. decrease per share earnings. c. increase liabilities. d. decrease liabilities. وزارة التعليم CHAPTER 7 Stocks and Bands 307

6. Preferred stock shares are often purchased by investment firms rather than individuals. True/False 7. The document stating the terms of a bond is the indenture. True/False. B. Treasury bills are short-term debt issued for less than one year. True/False, 9. Government securities: 1. pay interest, 2. must be retired at some specified time in the future, 3. may be callable. a. I and 2 b. I and 3 c. 2 and 3 d. 1, 2, and 3 KEY TERMS Match the terms listed with their definitions. Write the letters of the correct definitions. Term 1. Acquisition 2. Articles of association/ Articles of incorporation 3. Asset-backed securities 4. Board of directors 5. Call feature 6. Cash dividends 7. Common stock 8. Convertible bonds Your choice Definition a. A form of loan that is secured by a claim on real estate b. The right of current stockholders to maintain their proportionate ownership in the company c. A document that provides information about an investment such as a stock or mutual fund d. The total outstanding obligations of a country e. When a borrower pays back the money they owed in full f. A recapitalization achieved by changing the number of shares outstanding g. Classification schemes designed to indicate the risks associated with a particular debt instrument h. Bylaws, or procedures, for the operation of a joint stock company P308 Business Finance

Term 9. Coupon 10. Credit ratings 11. Current yield/ Yield to maturity 12. Date of record 13. Debentures 14. Default 15. Dilution 16. Ex dividend 17. Financial transaction costs 18. High-yield securities (junk bonds) 19. Indenture 20. Maturity date 21. Mortgage bonds 22. National debt 23. Pay date/ Distribution date 24. Payout ratio 25. Preemptive nights 26. Preferred stock 27. Principal Your choice Definition f. Security representing ownership in a corporation; those who own these securities have a final claim on the firm's assets and earnings after the firm has met its obligations to creditors and preferred stockholders j. The ratio of dividends to earnings per share k. The shares in a company that are owned by people who have the right to receive part of the company's profits before the holders of common stock I. Bonds issued to finance activities that generate Income m. The purchase of a company by another company n. The return on a stock expressed as dividend per share divided by the current share price o. The day on which a dividend is paid to stockholders p. Body elected by and responsible to stockholders to sel policy and hire management to run a corporation q. Accumulated profit after dividends T. When the borrower fails to meet the terms specified in the indenture of a debt issue s. The interest rate received by the bondholder t. A claim to a share of earnings after a debt has been settled u. The amount that a borrower owes v. A form of loan that may be converted Into (exchanged for) stock at the option of the person who has taken it out w. Poor-quality debt with high returns and a high probability of default x. Long-term debt instruments whose interest payments. vary with changes in short-term interest rates or the Consumer Price Index y. The right of a debtor to retire a bond prior to maturity z. The entitlement to subscribe to new shares listed during a capital increase, such as the sale of new stock shares za. Distribution from eamings paid into the bank accounts of shareholders وزارة التعليم CHAPTER 7 Stocks and Bonds 309

Term 28. Prospectus 29. Retained earnings 30. Retiring debt 31. Residual claim 32. Share dividends 33. Stock split 34. Tradable rights 35. Treasury shares 36. Variable Interest rate bonds 37. Yield 38. Zero coupon bonds Your choice Definition zb. Reduction in earnings per share as the result of the issuing of additional shares zc. The day by which a debt must be repaid zd. The rate of return on a bond investment ze. Costs involved in the buying or selling of financial products zf. A legal form of loan that is initially sold at a discount and on which Interest accrues and is paid at maturity zg. The day on which an Investor must own stock in order to receive the dividend payment zh. Unsecured bonds supported by the general credit of the company zi. A legal document specifying the terms of a debt issue zj. Stock that is given to stockholders as a return on their investment, often in place of cash zk. Referring to stock purchases which do not entitle the buyer to the next dividend zl. Stock held by the company for use as employee stock 310Business Finance KEY FORMULAS Price of stock after the split-Stock's price before the split x Reciprocal of the terms of the split. Dividend per share Payout ratio Earnings per share New bond price after inflation SAR Annual payment/SAR Required Investment return

MINI CASE 7.1 Company Stock Issues A successful medium-sized roast chicken restaurant is planning on expanding to multiple cities in Saudi Ambia. This will require new capital to purchase assets such as buildings, equipment, and restaurant inventory. The owners of the business believe that they will become profitable four years after their expansion. The business has existed as a joint stock company for five years and has a board of directors. Current investors are the only people holding stock in the company, but the business is now planning to issue common stock to the public to fund the expansion. Task 1. Describe the implications for the company of issuing common stock to the public. 2. Make a recommendation for or against paying dividends to common stockholders over the next four years. 3. When the company is profitable after expansion, evaluate the advantages and disadvantages of issuing cash dividends versus share dividends. وزارة التعليم CHAPTER 7 Stocks and Bands 311

pal 312 Business Finance M MINI CASE 7.2 Preferred vs Common Stock A friend of yours, Ziad, is looking to obtain additional personal income from investing in stock. He has evaluated a number of companies and is considering two options. The first is to purchase common stock from a business that has paid regular dividends over the last five years. He is also considering purchasing preferred stock in a different company. He has come to you for advice on these Iwo options. Task 1. Provide Ziad with the advantages and disadvantages for an investor in purchasing common stock. 2. Provide Ziad with the advantages and disadvantages for an investor in purchasing preferred stock. 3. Justify a recommendation you would give to Ziad.

Bonds MINI CASE 7.3 A large Saudi retailer management team is debating if they should reduce short-term and medium-term bank debt with the issuance of bonds. The retailer is a joint stock company. It has multiple locations and owns its buildings. The retailer's credit rating is BBB+. Some members of management believe that inflation will increase in the future. Task 1. Outline for management the advantages and disadvantages of issuing bonds. 2. Describe the different types of bonds the company could issue. What does a rating of BBB+ mean? 3. Outline the advantages of retiring or calling the issued bonds. وزارة التعليم CHAPTER 7 Stocks and Bonds 313

pul3114 Business Finance M CASE STUDY: SOURCES OF FUNDING The chief executive officer (CEO) of a telecommunication company, Fatimah, wants to be a strong participant in meeting the Saudi Vision 2030 goal of providing high-speed 5G broadband coverage in Saudi Arabia's rural zones. Fatimah's joint stock company will need to set up new cellular broadcast towers and mobile hotspots in remote areas. This will require new sources of funding for the company. Fatimah is working with her chief financial officer, Saad, on developing a funding plan to present to the company's board of directors.. The board wants to ensure that current stockholders have the opportunity to maintain their percentages of voting shares Saudi banks are potential investors, but Fatimah is concerned that current shareholders could lose control of the company if banks become major shareholders. Fatimah's company has been profitable and has paid dividends on a regular semi-annual cycle. This has resulted in a high stock price compared to other telecommunication companies. The company has a strong credit rating from both Saudi and international rating agencies, but this expansion into rural areas of Saudi Arabia does increase risk for the company Saad has identified several alternatives for funding this expansion. These include: 1. Suspending dividend payments to increase the retained earnings in the company to fund expansion. 2. Issuing additional shares of common stock. 3. Issuing shares of preferred stock. 4. Issuing bonds. 5. Issuing sukuk where investors become partial owners of the new equipment to be deployed in the rural expansion. 6. Developing callback and/or convertible strategies for security issues. Fatumah says to Saad, "Thank you for the alternative funding ideas. Obviously, we will need some combination of these various sources. Given the directives from the board, please develop a list of the advantages and disadvantages of each of these strategies. We can then identify our strategy and work on a communication plan for the board and our current shareholders." Saad replies, "I will do that right now. We need to keep in mind that this expansion will increase the overall risk exposure for our firm. This may give us an ability to negotiate with the banks for their investing options."

Study Questions 1. Combine any two of the six given sources, and explain the advantages and disadvantages of your combination. 2. What is your funding recommendation for Fatimal's company regarding your chosen combination? 3. How could the risk of this new expansion impact Fatimah's funding plans? Online Activity Go to the Saudi exchange (Tadawul) website. Search for "telecommunication companies. For one telecommunication company, identify dividend policies, if any. View the balance sheet statement to identify the amount of the company's shareholder's equity and if this has increased or decreased over time. حرارة التعليم CHAPTER 7 Stocks and Bonds 315