Stock Ownership We can classify a corporation according to whether its shares of stock
Stock Ownership We can classify a corporation according to whether its shares of stock
can be traded in financial markets. A corporation whose shares of stock are traded in financial markets is considered a public corporation. A corporation whose shares cannot be traded in financial markets is con- sidered a private corporation. 1
Federal securities laws—specifically the Securities Exchange Act of 1934, as modified in 1982—requires a corporation to register its securi- ties if it has more than 500 shareholders and more than $3 million of assets. To register securities, a corporation must file a detailed descrip- tion of the firm and the securities, as well as:
■ quarterly financial reports on Form 10-Q; ■ annual reports on Form 10-K, providing financial statement informa-
tion, along with other descriptive information about the firm; and ■ Form 8-K detailing specific events, such as the acquisition or disposi- tion of assets, as they occur.
We discussed these disclosures in Chapter 6. If a corporation has either less than 500 shareholders or less than $3 million of assets, it can choose not to register, and is referred to as a private corporation or a privately-held corporation. If it does register with the Securities and Exchange Commission, it’s considered a public corporation.
The shares of stock of a public corporation—also referred to as a publicly-held corporation—can be owned by and traded among the general public. Anyone can buy and sell the shares of stock in a public corporation and these shares can be traded in the financial markets—on national or regional stock exchanges or in the over-the-counter market.
1 A private corporation whose stock is owned among a very few individuals is re- ferred to as a closely-held corporation or a close corporation. In a close corporation,
the stock is owned by a single shareholder or a tightly-knit group of shareholders who are active in the management of the firm.
Common Stock
What difference does it make whether the corporation’s stock is pri- vately held or publicly-held? There are many differences. One difference is the stock’s marketability. If the shares are publicly traded, they are marketable. Investors can easily buy or sell the shares. If shares are privately-held, there may be restrictions as to whom you can sell your shares, possibly making it difficult to get cash when you need it.
Another difference is the diversification of the owners’ wealth. If the shares are closely-held, the owners are usually also the managers. Owner-managers have a great deal of their wealth tied up with the cor- poration. Not only does the value of their stock depend on the fortunes of the company, so does their income. In a publicly-held corporation, owner-managers can sell off parts of their ownership.
Still another difference is the firm’s access to capital. A publicly- traded corporation can raise new capital by issuing more shares to the general public. A privately-held corporation may not be able to do this since ownership may be restricted to a few shareholders. In addition, a privately-held corporation may reach a point when the number of share- holders and the size of the firm increases to the point requiring the regis- tration of securities—changing the firm’s status from private to public.
A further difference is confidentiality. A publicly-held corporation is required to disclose information to shareholders and the investing pub- lic through financial statements, annual reports, and press releases. Securities laws and exchange rules require publicly-traded corporations to disclose to investors important information such as a merger, a new product or discovery, the sale of a significant asset, and labor disputes. Private corporations do not have to reveal any information to the pub- lic. Therefore, a private corporation has the advantage because it is more difficult for its publicly-traded competitors to figure out what it is doing. For example, the two candy companies, Hershey Foods Corpora- tion (Hershey Kisses, Reeses Peanut Butter Cups) and Mars, Incorpo- rated (M&Ms, Milky Way bars), are competitors. Hershey Foods is publicly-traded, whereas Mars is a private company. Mars has access to all of Hershey’s financial statements and other disclosures, whereas Her- shey has no financial information on Mars.
Another difference is the cost of communication. A publicly-traded corporation must file annual financial statements with the Securities and Exchange Commission, prepare and send annual reports to sharehold- ers, and correspond with shareholders (Securities Exchange Act of 1934, Rule 13a). The costs of these communications can add up, in terms of both the direct expenses for accountants, lawyers, and other personnel, and the indirect expense of tying up managements’ time in shareholders’ affairs instead of managing the firm.
FINANCING DECISIONS
All these differences must be weighed in deciding whether to be a private or a public corporation. There are over 4 million corporations in the U.S., but only about 9,000 have publicly-traded stock. The fact that we observe some private and some public corporations tells us that the weighing these factors can go either way.
Corporations do change their status, going from public to private or private to public. It is possible that as a corporation changes—in terms of the ownership, the types of investments it makes, and its need for capital—a change from public to private or private to public may be appropriate. RJR Nabisco went private in 1989, only to go public once again as RJR Nabisco Holdings two years later when it needed more capital.
Parts
» Financial Management and Analysis
» SECURITIES MARKETS The primary function of a securities market—whether or not it has a
» Stock Exchanges Stock exchanges are formal organizations, approved and regulated by
» Stock Market Indicators Stock market indicators have come to perform a variety of functions,
» Efficient Markets Investors do not like risk and they must be compensated for taking on
» THE FEDERAL RESERVE SYSTEM The United States has a central monetary authority known as the Fed-
» The Fed and the Money Supply Financial managers and investors are interested in the supply and
» Deposit Institutions Traditionally, the United States has had several types of deposit institu-
» Investment Banking The primary market involves the distribution to investors of newly
» Interest Rates and Yields Because bonds are traded in the secondary market, the price of the bond
» The Risk Premium Market participants talk of interest rates on non-Treasury securities as
» OPTIONS An option is a contract in which the writer of the option grants the
» Buying Call Options The purchase of a call option creates a position referred to as a long call
» Buying Put Options The buying of a put option creates a financial position referred to as a
» CAP AND FLOOR AGREEMENTS There are agreements available in the financial market whereby one
» I n assessing a company’s current and future cash flows, the financial
» Depreciation for Tax Purposes For accounting purposes, a firm can select a method of depreciation
» Capital Gains We tend to use the term “capital gain” loosely to mean an increase in the
» Current assets (also referred to as circulating capital and working
» Noncurrent Assets Noncurrent assets are assets that are not current assets; that is, it is not
» Deferred Taxes Along with long-term liabilities, the analyst may encounter another
» THE INCOME STATEMENT An income statement is a summary of the revenues and expenses of a
» THE STATEMENT OF CASH FLOWS The statement of cash flows is a summary over a period of time of a
» T he notion that money has a time value is one of the most basic con-
» DETERMINING THE PRESENT VALUE Now that we understand how to compute future values, let’s work the
» Shortcuts: Annuities There are valuation problems that require us to evaluate a series of level
» THE CALCULATION OF INTEREST RATES
» T here are a number of factors that affect a stock’s price and its value to
» Dividend Valuation Model If dividends are constant forever, the value of a share of stock is the
» Returns on Common Stock As we saw in the preceding section, the value of a stock is the present
» Straight Coupon Bond Suppose you are considering investing in a straight coupon bond that:
» Returns on Bonds If you invest in a bond, you realize a return from the interest it pays (if
» Coupon Bonds The present value of a bond is its current market price, which is the dis-
» Callable Bonds Some bonds have a feature, referred to as a call feature, that allows the
» RISK Whenever you make a financing or investment decision, there is some
» Financial Risk When we refer to the cash flow risk of a security, we expand our con-
» Reinvestment Rate Risk Another type of risk is the uncertainty associated with reinvesting cash
» Interest Rate Risk Interest rate risk is the sensitivity of the change in an asset’s value to
» Currency Risk In assessing the attractiveness of an investment, we estimated future cash
» 5 (Continued) Portfolio of Investment C and Investment D
» Portfolio Size and Risk What we have seen for a portfolio with two assets can be extended to
» I n Chapters 8 through 10, we discussed and practiced techniques for
» The Cost of Debt Because Congress allows you to deduct from your taxable income the
» The Cost of Common Stock The cost of common stock is the cost of raising one more dollar of com-
» INTEGRATIVE EXAMPLE: ESTIMATING THE COST OF CAPITAL FOR DUPONT
» CAPITAL BUDGETING Because a firm must continually evaluate possible investments, capital
» Investment Cash Flows When we consider the cash flows of an investment we must also consider
» Asset Disposition At the end of the useful life of an asset, the firm may be able to sell it or
» Change in Expenses When a firm takes on a new project, the costs associated with it will
» Putting It All Together Here’s what we need to put together to calculate the change in the firm’s
» The Analysis To determine the relevant cash flows to evaluate this expansion, let’s
» The Problem The new equipment costs $300,000 and is expected to have a useful life of
» T he value of a firm today is the present value of all its future cash
» Payback Period The payback period for a project is the length of time it takes to get your
» Discounted Payback Period The discounted payback period is the time needed to pay back the origi-
» Net Present Value If offered an investment that costs $5,000 today and promises to pay
» Net Present Value Decision Rule
» Profitability Index The profitability index (PI) is the ratio of the present value of change in
» Stand-Alone versus Market Risk If we have some idea of the uncertainty associated with a project’s
» Sensitivity Analysis Estimates of cash flows are based on assumptions about the economy,
» Simulation Analysis Sensitivity analysis becomes unmanageable if we change several factors
» Options on Real Assets The valuation of stock options is rather complex, but with the assis-
» OVERVIEW OF DEBT OBLIGATIONS In a debt obligation, the borrower receives money in exchange for a
» Repayment Schedule Term loans are usually repaid in installments either monthly, quarterly,
» Interest In the United States, interest is typically paid twice a year at six month
» Debt Retirement By the maturity date of the bond, the issuer must pay off the entire par
» Rating Systems In all systems the term high grade means low default risk, or conversely,
» S uppose you buy a new car that costs $20,000 and you pay cash for it.
» Limited Liability The corporate form of doing business is attractive to owners of a busi-
» Stock Ownership We can classify a corporation according to whether its shares of stock
» Voting Rights Common shareholders are generally granted rights to
» Corporate Democracy Corporate democracy gives owners of the corporation a say in how to
» Methods of Repurchasing Stock
» Dividends Although a firm’s board of directors declares a dividend on its preferred
» Sinking Funds Because there is no legal obligation to pay the preferred dividend and
» DEBT VERSUS EQUITY The combination of debt and equity used to finance a firm’s projects is
» CAPITAL STRUCTURE AND TAXES We’ve seen how the use of debt financing increases the risk to owners;
» Interest Tax Shield An interesting element introduced into the capital structure decision is
» Unused Tax Shields The value of a tax shield depends on whether the firm can use an interest
» PUTTING IT ALL TOGETHER As a firm increases the relative use of debt in the capital structure, its
» A s we saw in Part Three, managers base decisions about investing in
» CASH MANAGEMENT Cash flows out of a firm as it pays for the goods and services it pur-
» The Baumol Model The Baumol Model is based on the Economic Order Quantity (EOQ)
» The Miller-Orr Model The Baumol Model assumes that cash is used uniformly throughout the
» The Check Clearing Process The process of receiving cash from customers involves several time-
» RECEIVABLES MANAGEMENT When a firm allows customers to pay for goods and services at a later
» Captive Finance Subsidiaries Some firms choose to form a wholly-owned subsidiary—a corporation
» The Economic Order Quantity Model The Economic Order Quantity (EOQ) model helps us determine what
» Just-in-Time Inventory The goal of the just-in-time (JIT) inventory model is to cut down on the
» Monitoring Inventory Management We can monitor inventory by looking at financial ratios in much the
» Add-on-interest Another way of stating interest is with add-on interest, where the total
» Trade Credit Trade credit is granted by a supplier to a customer purchasing goods or
» Commercial Paper Commercial paper is an unsecured promissory note with a fixed matu-
» Types of Inventory Financing There are several different types of loan arrangements that involve
» SPECIALIZED COLLATERALIZED BORROWING ARRANGEMENT FOR FINANCIAL INSTITUTIONS
» RATIOS AND THEIR CLASSIFICATION
» RETURN-ON-INVESTMENT RATIOS Return-on-investment ratios compare measures of benefits, such as earn-
» The Du Pont System The returns on investment ratios give us a “bottom line” on the perfor-
» LIQUIDITY Liquidity reflects the ability of a firm to meet its short-term obligations
» PROFITABILITY RATIOS We have seen that liquidity ratios tell us about a firm’s ability to meet its
» Using a Benchmark To interpret a firm’s financial ratios we need to compare them with the
» INTEGRATIVE EXAMPLE: FINANCIAL ANALYSIS OF WAL-MART STORES 6
» Dilutive Securities For a company having securities that are dilutive—meaning they could
» ANALYSTS’ FORECASTS There are many financial services firms offering projections on different
» PRICE-EARNINGS RATIO Many investors are interested in how the earnings are valued by the mar-
» FREE CASH FLOW Cash flows without any adjustment may be misleading because they do
» NET FREE CASH FLOW There are many variations in the calculation of cash flows that are used
» Using Cash Flow Information The analysis of cash flows provides information that can be used along
» THE GLOBAL ECONOMY Many countries export a substantial portion of the goods and services
» FOREIGN CURRENCY Doing business outside of one’s own country requires dealing with the cur-
» The Euro The European Union consists of 15 European member countries that
» Global Equity Market In 1985, Euromoney surveyed several firms that either listed stock on a
» Currency Swaps When issuing bonds in another country where the bonds are not denom-
» Currency Option Contracts In contrast to a forward or futures contract, an option gives the option
» A s an alternative to the issuance of a corporate bond, a corporation
» WHAT RATING AGENCIES LOOK AT IN RATING ASSET-BACKED SECURITIES
» Third-Party Guarantees Perhaps the easiest form of credit enhancement to understand is insur-
» EXAMPLE OF AN ACTUAL STRUCTURED FINANCE TRANSACTION
» Accounting for Capital Leases
» FEDERAL INCOME TAX REQUIREMENTS FOR TRUE LEASE TRANSACTIONS
» Direct Cash Flow from Leasing When a firm elects to lease an asset rather than borrow money to pur-
» S tructured financing is a debt obligation that is backed by the value of
» CREDIT IMPACT OBJECTIVE While the sponsor or sponsors of a project financing ideally would pre-
» A business that maximizes its owners’ wealth allocates its resources
» Budgeting In budgeting, we bring together analyses of cash flows, projected income
» Taxes and Transaction Costs The Black-Scholes option pricing model ignores taxes and transaction
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