Financing and Stock Market Operations

1
Financing and Stock Market Operations

• Understanding Optimal Financing
• Professor A. D. Amar, Ph.D.
• SETON HALL UNIVERSITY

2
Compute Current CoC

• Study structure of firms capital (weights and
  components)
• Assemble all components of capital
• Weights on each component
• Compute cost of each component
• Compute cost of capital

3
Sources of Capital (Components)

• Equity
• (a) Internal Equity
• (b) External Equity
• Debt
• (a) Short Term Notes
• (b) Overdraft Account (Computer Loan)
• Hybrid
• (a) Preferred Stock
• (b) Convertible
• (c) Debenture

4
Cost of Internal Equity

• Gordons Formula
• kie (d0 P0 x g) ? P0
• Where,
• kie Cost of internal equity
• d0 Current dividend per share
• P0 Current market price of the common
  stock
• g Expected rate of growth in
  dividend on common stock

5
Cost of External Equity

• kee (d0 (P0-f) x g) ? (P0-f)
• Where,
• Kee Cost of external equity
• d0 Current dividend per share
• P0 Current market price of the common
  stock
• g Expected rate of growth in
  dividend on common stock
• f floatation cost

6
Cost of Equity II

• When a company does not declare dividend
• Cost of equity can be estimated as follows
• kie 1 / (P/e)
• kee 1 / ((P-f)/e)

7
Cost of Debt

• Interest rate on the short term note
• Cost of bond

8
Cost of Capital

• CoC wee (kee) wie (kie) wd (kd)
• Monitor cost of capital on a regular basis and
  readjust components to keep the cost low.

9
Minimizing CoC

• Minimize component costs
• Put more weight on low cost components and less
  on high cost components. Ideally, eliminate high
  cost components from the structure.

10
Minimizing Cost of Equity

• Plough back earnings as far as possible
• Keep stock price high, especially if you need new
  equity
• Low debt
• High dividend
• Set a dividend policy

11
Theories Guiding Dividends

• 1. Dividend Preference Theory or BIH Theory
• A Bird in Hand is Better than two in a bush
• 2. Dividend Irrelevance Theory or
• Perfect Market Theory
• 3. Clientele Theory

12
Dividend Policy Terminology

• Payout Ratio K d/e
• Date of declaration
• Ex-Dividend Date
• Payout Date
• Where,
• d dividend per share
• e earnings per share

13
Dividend Policies

• Constant Payout Ratio Policy
• DPS K x e Constant
• Stable Dividend Policy
• DPS -gt K x e
• Residual Dividend Policy
• DPS (NI Internal Financial Needs) / N
• N Number of shares of common outstanding
• NI Net Income

14
How to Keep Stock Price High?

• Low debt
• High dividends