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Stoc re()rcase may be *ie+ed as an alternati*e to (aying di*idends in tat it is anoter metod of ret)rning cas to in*estors, A stoc re()rcase occ)rs +en a com(any assstocolders to tender teir sares for re()rcase by te com(any, Tere are se*eralreasons +y a stoc re()rcase can increase *al)e for stocolders, -irst$ a re()rcasecan be )sed to restr)ct)re te com(any's ca(ital str)ct)re +ito)t increasing tecom(any's debt load, Additionally$ rater tan a com(any canging its di*idend (olicy$ itcan offer *al)e to its stocolders tro)g stoc re()rcases$ ee(ing in mind tat ca(italgains ta.es are lo+er tan ta.es on di*idends,

Advantages of a Stock Repurchase

"any com(anies initiate a sare re()rcase at a (rice le*el tat management deems agood entry (oint, Tis (oint tends to be +en te stoc is estimated to be )nder*al)ed, Ifa com(any no+s its b)siness and relati*e stoc (rice +ell$ +o)ld it ()rcase its stoc (rice at a ig le*el? Te ans+er is no$ leading in*estors to belie*e tat management (ercei*es its stoc (rice to be at a lo+ le*el,

/nlie a cas di*idend$ a stoc re()rcase gi*es te decision to te in*estor, Astocolder can coose to tender is sares for re()rcase$ acce(t te (ayment and (ayte ta.es, 0it a cas di*idend$ a stocolder as no coice b)t to acce(t te di*idendand (ay te ta.es,

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At times$ tere may be a bloc of sares from one or more large sareolders tat co)ldcome into te maret$ b)t te timing may be )nno+n, Tis (roblem may act)ally ee( (otential stocolders a+ay since tey may be +orried abo)t a flood of sares comingonto te maret and lessening te stoc's *al)e, A stoc re()rcase can be 1)ite )sef)l intis sit)ation,

Disadvantage of a Stock Repurchase

-rom an in*estor's (ers(ecti*e$ a cas di*idend is de(endable a stoc re()rcase$o+e*er$ is not, -or some in*estors$ te de(endability of te di*idend may be moreim(ortant, As s)c$ in*estors may in*est more ea*ily in a stoc +it a de(endabledi*idend tan in a stoc +it less de(endable re()rcases,

In addition$ a com(any may find itself in a (osition +ere it ends )( (aying too m)c forte stoc it re()rcases, -or e.am(le$ say a com(any re()rcases its sares for 3% (ersare on 4)ne &, On 4)ne &%$ a ma5or )rricane damages te com(any's (rimaryo(erations, Te com(any's stoc terefore dro(s do+n to 2%, T)s$ te &%6(er6sare

difference is a lost o((ort)nity to te com(any,

O*erall$ stocolders +o offer teir sares for re()rcase may be at a disad*antage iftey are not f)lly a+are of all te details, As s)c$ an in*estor may file a la+s)it +it tecom(any$ +ic is seen as a ris,

Price Effect of a Stock Repurchase

A stoc re()rcase ty(ically as te effect of increasing te (rice of a stoc,

Example: 7e+co as 2%$%%% sares o)tstanding and a net income of &%%$%%%, Tec)rrent stoc (rice is 8%, 0at effect does a 9: stoc re()rcase a*e on te (rice (er

sare of 7e+co's stoc?

Answer: To ee( it sim(le$ (rice6(er6earnings ratio ; is te *al)ation metric )sed to*al)e 7e+co's (rice (er sare,

7e+co's c)rrent E


3/21

Lie cas di*idends$ stoc di*idends and stoc s(lits also a*e effects on a com(any'sstoc (rice, Stock DividendsStoc di*idends are similar to cas di*idends o+e*er$ instead of cas$ a com(any (ays

o)t stoc, As a res)lt$ a com(any's sares o)tstanding +ill increase$ and te com(any'sstoc (rice +ill decrease, -or e.am(le$ s)((ose 7e+co decides to iss)e a &%: stocdi*idend, Eac c)rrent stocolder +ill t)s a*e &%: more sares after te di*idend isiss)ed,

Stock Splits

Stoc s(lits occ)r +en a com(any (ercei*es tat its stoc (rice may be too ig, Stocs(lits are )s)ally done to increase te li1)idity of te stoc ;more sares o)tstanding> andto mae it more affordable for in*estors to b)y reg)lar lots ;a reg)lar lot &%% sares>,Com(anies tend to +ant to ee( teir stoc (rice +itin an o(timal trading range,

Stoc s(lits increase te n)mber of sares o)tstanding and red)ce te (ar or stated *al)e (er sare of te com(any's stoc, -or e.am(le$ a t+o6for6one stoc s(lit means tat tecom(any stocolders +ill recei*e t+o sares for e*ery sare tey c)rrently o+n, Tes(lit +ill do)ble te n)mber of sares o)tstanding and red)ce by alf te (ar *al)e (ersare, E.isting sareolders +ill see teir sareoldings do)ble in 1)antity$ b)t tere +ill be no cange in te (ro(ortional o+nersi( re(resented by te sares, -or e.am(le$ asareolder o+ning 2$%%% sares o)t of &%%$%%% before a stoc s(lit +o)ld o+n 8$%%%sares o)t of 2%%$%%% after a stoc s(lit,

Stock Split Example:S)((ose 7e+co's stoc reaces % (er sare, Te com(any's management belie*es tis

is too ig and tat some in*estors may not in*est in te com(any as a res)lt of te initial (rice re1)ired to b)y te stoc, As s)c$ te com(any decides to s(lit te stoc to maete entry (oint of te sares more accessible,

-or sim(licity$ s)((ose 7e+co initiates a 26for6& stoc s(lit, -or eac sare tey o+n$ allolders of 7e+co stoc +ill recei*e t+o 7e+co sares (riced at 3% eac$ and tecom(any's sares o)tstanding +ill do)ble, Kee( in mind tat te com(any's o*eralle1)ity *al)e remains te same, Say tere are one million sares o)tstanding and tecom(any's initial e1)ity *al)e is % million ;% (er sare . & million sareso)tstanding>, Te e1)ity *al)e after te s(lit is still % million ;3% (er sare . 2 millionsares o)tstanding>,

0ile stoc (rices +ill most liely rise after a s(lit or di*idend ;remember (riceincreases are ca)sed by (ositi*e signals a com(any generates +it res(ect to f)t)reearnings>$ if (ositi*e ne+s does not follo+$ te com(any's stoc (rice +ill generally fall bac to its original le*el, Some in*estors tin tat stoc s(lits and stoc di*idends are)nnecessary and do little more tan create more stocs, ;-or f)rter reading on stocs(lits$ see Bersire's Stoc S(lits@ ood B)y or oodbye?and To( Stoc Target


4/21

Introd)ction To Daising Ca(ital

0en most (eo(le tin abo)t a com(any raising ca(ital$ tey tin abo)t a (ri*ate

com(any going ()blic 6 selling an initial ()blic offering ;I of stoc, An I and attractsig61)ality (ersonnel at all le*els$ incl)ding senior management, S)c com(anies aregro+t6oriented tey ans+er to a board of directors and sareolders +o contin)allydemand increased (rofitability$ and are 1)ic to rectify management (roblems andre(lace (oorly (erforming senior e.ec)ti*es,

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5/21

B)t before )ndertaing te com(le.$ e.(ensi*e and time6cons)ming (re(arations andinc)rring te riss in*ol*ed$ te )(side and do+nside of tis critical mo*e m)st be f)llyassessed, Alto)g tere are n)mero)s benefits to being a ()blic com(any$ tis (restigecomes +it an increased amo)nt of restrictions and re1)irements, ;Learn more in Te")ry 0aters Of Te I

If te iss)e +ill be for less tan 9 million$ te com(any need only file a concise offeringstatement +it te SEC, A sale to fe+er tan 39 in*estors is considered a (ri*ate sale and

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6/21

eliminates te need to file a registration statement +it te SEC, Ho+e*er$ )nregisteredsec)rities are not as easy to sell as registered sec)rities, ;-or related reading$ see Jal)ing

ash !ffer

A cas offer is one of t+o ty(es of ()blic iss)es, 0e'll disc)ss te oter ty(e$ a rigtsoffer$ later in tis section, A cas offer maes sares a*ailable to te general ()blic in aninitial ()blic offering, B)t first$ let's go o*er te differences bet+een (ri*ate and ()blic com(anies,

A (ri*ately eld com(any as fe+er sareolders$ and its o+ners don't a*e to disclosem)c information abo)t te com(any, Anybody can go o)t and incor(orate a com(any 5)st ()t in some money$ file te rigt legal doc)ments and follo+ te re(orting r)les ofyo)r 5)risdiction, "ost small b)sinesses are (ri*ately eld, B)t large com(anies can be (ri*ate$ too, id yo) no+ tat as of -ebr)ary 2%&2$ IKEA$ omino's


7/21

6 Being listed on a ma5or stoc e.cange carries a considerable amo)nt of (restige, In te (ast$ only (ri*ate com(anies +it strong f)ndamentals co)ld 1)alify for an I


8/21

Once all sides agree to a deal$ te in*estment ban ()ts togeter a registration statementto be filed +it te SEC, Tis doc)ment contains information abo)t te offering as +ellas com(any info s)c as financial statements$ management bacgro)nd$ any legal (roblems$ +ere te money is to be )sed and insider oldings, Te SEC ten re1)ires acooling off (eriod$ in +ic it in*estigates and maes s)re all material information as

been disclosed, Once te SEC a((ro*es te offering$ a date ;te effecti*e date> is set+en te stoc +ill be offered to te ()blic,

)ring te cooling off (eriod te )nder+riter ()ts togeter +at is no+n as te rederring, Tis is an initial (ros(ect)s containing all te information abo)t te com(anye.ce(t for te offer (rice and te effecti*e date$ +ic aren't no+n at tat time, 0it tered erring in and$ te )nder+riter and com(any attem(t to y(e and b)ild )( interestfor te iss)e, Tey go on a road so+ 6 also no+n as te Fdog and (ony so+F 6 +erete big instit)tional in*estors are co)rted,

As te effecti*e date a((roaces$ te )nder+riter and com(any sit do+n and decide on

te initial sare (rice, Tis isn't an easy decision@ it de(ends on te com(any$ te s)ccessof te road so+ and$ most im(ortantly$ c)rrent maret conditions, Of co)rse$ it's in bot (arties' interest to get as m)c as (ossible,

-inally$ te sec)rities are sold on te stoc maret and te money is collected fromin*estors,

"hat About (e%

As yo) can see$ te road to an I


9/21

s(ecified (eriod of time, Loc6)( (eriods ty(ically last % days ;si. monts> b)t can onoccasion last for as little as &2% days or as long as one year,

/nder+riters +ill a*e com(any e.ec)ti*es$ managers$ em(loyees and *ent)re ca(italistssign loc6)( agreements to ens)re an element of stability in te stoc's (rice in te first

fe+ monts of trading, 0en loc6)(s e.(ire$ restricted (eo(le are (ermitted to sell teirstoc$ +ic sometimes ;if tese insiders are looing to sell teir stoc> res)lts in adrastic dro( in sare (rice d)e to te )ge increase in s)((ly of stoc, ;Learn more inI

7e+ E1)ity Sales

A com(any tat as already eld an I


10/21

One of te +ays te in*estment comm)nity meas)res a com(any's (rofitability is basedon earnings (er sare ;E$ +ic allo+s for a more meaningf)l com(arison ofcor(orate fig)res, In its first year of ()blic o+nersi($ ad an E, In oter +ords$ eac sare of stoceld by a sareolder +as +ort & of earnings,

S)bse1)ently$ tings are looing )( for $ +ic (rom(ts management to raise moree1)ity ca(ital tro)g a secondary offering$ +ic is s)ccessf)l, In tis instance$ tecom(any only iss)es 9%$%%% sares$ +ic (rod)ces 9%$%%% of additional e1)ity, Tecom(any ten goes on to a*e anoter good year +it a net income of &29$%%%,

Tat's te good ne+s$ at least for te com(any, Ho+e*er$ te (oint of *ie+ of te originalin*estors 6 tose +o became sareolders tro)g te I$ +ic com(ares )nfa*orably tote & E


11/21

A ()blic com(any is s)b5ect to SEC o*ersigt and reg)lations$ incl)ding strict disclos)rere1)irements, Among te re1)ired disclos)res is information abo)t senior management (ersonnel 6 (artic)larly com(ensation 6 +ic is often criticiGed by staeolders,

A ()blic com(any is s)b5ect to sareolder s)its$ +eter +arranted or not, La+s)its may

be based on allegations of self6trading or insider trading, Tey may callenge e.ec)ti*ecom(ensation$ or tey may o((ose or 1)estion ma5or management decisions, Sometimesa single$ disgr)ntled sareolder may bring s)it and ca)se e.(ensi*e and time6cons)mingtro)ble for a ()blicly traded firm,


12/21

Tro)bled com(anies ty(ically )se rigts iss)es to (ay do+n debt$ es(ecially +en teyare )nable to borro+ more money, B)t not all com(anies tat ()rs)e rigts offerings aresay, Some +it clean balance seets )se tem to f)nd ac1)isitions and gro+tstrategies, -or reass)rance tat it +ill raise te finances$ a com(any +ill )s)ally$ b)t notal+ays$ a*e its rigts iss)e )nder+ritten by an in*estment ban, ;Dead more abo)t

in*estment baning in Te 0orld's "ost

,ow Rights Issues "ork So$ o+ do rigts iss)es +or? Te best +ay to e.(lain is tro)g an e.am(le,

Let's say yo) o+n &$%%% sares in 0obble Telecom$ eac of +ic is +ort 9,9%, Tecom(any is in a bit of financial tro)ble and sorely needs to raise cas to co*er its debtobligations, 0obble terefore anno)nces a rigts offering$ in +ic it (lans to raise 3%million by iss)ing &% million sares to e.isting in*estors at a (rice of 3 eac, B)t tisiss)e is a tree6for6&% rigts iss)e, In oter +ords$ for e*ery &% sares yo) old$ 0obble

is offering yo) anoter tree at a dee(ly disco)nted (rice of 3, Tis (rice is 89: lesstan te 9,9% (rice at +ic 0obble stoc trades, ;-or f)rter reading$ see/nderstanding Stoc S(lits,>

As a sareolder$ yo) essentially a*e tree o(tions +en considering +at to do inres(onse to te rigts iss)e, o) can ;&> s)bscribe to te rigts iss)e in f)ll$ ;2> ignoreyo)r rigts or ;3> sell te rigts to someone else, Here's o+ to ()rs)e eac o(tion andte (ossible o)tcomes,

1. Take up the rights to purchase in full To tae ad*antage of te rigts iss)e in f)ll$ yo) +o)ld need to s(end 3 for e*ery

0obble sare tat yo) are entitled to )nder te iss)e, As yo) old &$%%% sares$ yo) can b)y )( to 3%% ne+ sares ;tree sares for e*ery &% yo) already o+n> at tis disco)nted (rice of 3$ gi*ing a total (rice of %%,

Ho+e*er$ +ile te disco)nt on te ne+ly iss)ed sares is 89:$ it +ill not stay tere, Temaret (rice of 0obble sares +ill not be able to stay at 9,9% after te rigts iss)e iscom(lete, Te *al)e of eac sare +ill be dil)ted as a res)lt of te increased n)mber ofsares iss)ed, To see if te rigts iss)e does in fact gi*e a material disco)nt$ yo) need toestimate o+ m)c 0obble's sare (rice +ill be dil)ted,

In estimating tis dil)tion$ remember tat yo) can ne*er no+ for certain te f)t)re *al)eof yo)r e.(anded olding of te sares$ since it can be affected by any n)mber of b)siness and maret factors, B)t te teoretical sare (rice tat +ill res)lt after te rigtsiss)e is com(lete 6 +ic is te e.6rigts sare (rice 6 is (ossible to calc)late, Tis (riceis fo)nd by di*iding te total (rice yo) +ill a*e (aid for all yo)r 0obble sares by tetotal n)mber of sares yo) +ill o+n, Tis is calc)lated as follo+s@

&$%%% e.isting sares at 9,9% 9$9%%

3%% ne+ sares for cas at 3 %%

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13/21

Jal)e of &$3%% sares $8%%

E.6rigts *al)e (er sare 8,2 ;$8%%,%%=&$3%% sares>

So$ in teory$ as a res)lt of te introd)ction of ne+ sares at te dee(ly disco)nted (rice$te *al)e of eac of yo)r e.isting sares +ill decline from 9,9% to 8,2, B)t remember$

te loss on yo)r e.isting sareolding is offset e.actly by te gain in sare *al)e on tene+ rigts@ te ne+ sares cost yo) 3$ b)t tey a*e a maret *al)e of 8,2, Tese ne+sares are ta.ed in te same year as yo) ()rcased te original sares$ and tey arecarried for+ard to co)nt as in*estment income$ b)t tere is no interest or oter ta. (enalties carged on tis carried6for+ard$ ta.able in*estment income,

2. Ignore the rights issue o) may not a*e te %% to ()rcase te additional 3%% sares at 3 eac$ so yo) canal+ays let yo)r rigts e.(ire, B)t tis is not normally recommended, If yo) coose to donoting$ yo)r sareolding +ill be dil)ted tans to te e.tra sares iss)ed,

3 Sell your rights to other investors In some cases$ rigts are not transferable, Tese are no+n as Fnon6reno)nceable rigts,FB)t in most cases$ yo)r rigts allo+ yo) to decide +eter yo) +ant to tae )( te o(tionto b)y te sares or sell yo)r rigts to oter in*estors or to te )nder+riter, Digts tatcan be traded are called Freno)nceable rigts$F and after tey a*e been traded$ te rigtsare no+n as Fnil6(aid rigts,F

To determine o+ m)c yo) may gain by selling te rigts$ yo) need to estimate a *al)eon te nil6(aid rigts aead of time, Again$ a (recise n)mber is diffic)lt$ b)t yo) can get aro)g *al)e by taing te *al)e of e.6rigts (rice and s)btracting te rigts iss)e (rice,So$ at te ad5)sted e.6rigts (rice of 8,2 less 3$ yo)r nil6(aid rigts are +ort &,2

(er sare, Selling tese rigts +ill create a ca(ital gain for yo),

-e "arned It is a+f)lly easy for in*estors to get tem(ted by te (ros(ect of b)ying disco)nted sares+it a rigts iss)e, B)t it is not al+ays a certainty tat yo) are getting a bargain, B)t besides no+ing te e.6rigts sare (rice$ yo) need to no+ te ()r(ose of te additionalf)nding before acce(ting or re5ecting a rigts iss)e, Be s)re to loo for a com(ellinge.(lanation of +y te rigts iss)e and sare dil)tion are needed as (art of te reco*ery (lan, S)re$ a rigts iss)e can offer a 1)ic fi. for a tro)bled balance seet$ b)t tat doesn'tnecessarily mean management +ill address te )nderlying (roblems tat +eaened te balance seet in te first (lace, Sareolders so)ld be ca)tio)s, ;Learn abo)t oter

in*estments to be ca)tio)s of in &% )estionable In*estments and angero)s Ad*ice -orBeginner In*estors,>

il)tion

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il)ti*e stoc is any sec)rity tat dil)tes te o+nersi( (ercentage of c)rrentsareolders 6 tat is$ any sec)rity tat does not a*e some sort of embedded anti6dil)tion (ro*ision, Te reason +y dil)ti*e stoc as s)c negati*e connotations is 1)ite sim(le@a com(any's sareolders are its o+ners$ and anyting tat decreases an in*estor's le*elof o+nersi( also decreases te *al)e of te in*estor's oldings,

O+nersi( can be dil)ted in a n)mber of different +ays@

&, Secondar# !fferings: -or e.am(le$ if a com(any ad a total of &%% sares on temaret and its management decided to iss)e anoter &%% stocs$ ten te o+ners of tefirst &%% stocs +o)ld face a 9%: dil)tion factor, -or a real life e.am(le of tis scenario$consider te secondary offering made by oogle Inc, in te fall of 2%%9, Te com(anydecided to iss)e more tan &8 million sares of common stoc to raise money forFgeneral cor(orate ()r(oses$F and it dil)ted ten6c)rrent oldings,

2, onvertible Debt.onvertible E/uit#: 0en a com(any iss)es con*ertible debt$ it

means tat debtolders +o coose to con*ert teir sec)rities into sares +ill dil)tec)rrent sareolders' o+nersi( +en tey con*ert, In many cases$ con*ertible debtcon*erts to common stoc at some sort of (referential con*ersion ratio, -or e.am(le$eac &$%%% of con*ertible debt may con*ert to &%% sares of common stoc$ t)sdecreasing c)rrent stocolders' total o+nersi(,

Con*ertible e1)ity is often called con*ertible (referred stoc , Tese inds of sares also)s)ally con*ert to common stoc on some ind of (referential ratio 6 for e.am(le$ eaccon*ertible (referred stoc may con*ert to &% sares of common stoc$ t)s also dil)tingo+nersi( (ercentages of te common stocolders,

3, "arrants0 Rights0 !ptions and other claims on securit#: 0en e.ercised$ tesederi*ati*es are e.canged for sares of common stoc tat are iss)ed by te com(any toits olders, Information abo)t dil)ti*e stoc$ o(tions$ +arrants$ rigts$ and con*ertibledebt and e1)ity can be fo)nd in a com(any's ann)al filings, ;-or more information onsareolder dil)tion and its costs$ cec o)t o)r Acco)nting And Jal)ing ESOs-eat)re and A 7e+ A((roac To E1)ity Com(ensation,> "arnings Signs of DilutionBeca)se dil)tion can red)ce te *al)e of an indi*id)al in*estment$ retail in*estors so)ld be a+are of +arnings signs tat may (recede a (otential sare dil)tion, Basically$ anyemerging ca(ital needs or gro+t o((ort)nities may (reci(itate sare dil)tion,

Tere are many scenarios in +ic a firm co)ld re1)ire an e1)ity ca(ital inf)sion f)nds

may sim(ly be needed to co*er e.(enses, In a scenario +ere a firm does not a*e teca(ital to ser*ice c)rrent liabilities and te firm is indered from iss)ing ne+ debt d)e toco*enants of e.isting debt$ an e1)ity offering of ne+ sares may be necessary,

ro+t o((ort)nities are anoter indicator of a (otential sare dil)tion, Secondaryofferings are commonly )sed to obtain in*estment ca(ital tat may be needed to f)ndlarge (ro5ects and ne+ *ent)res,

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16/21

+as con*ertible into fi*e common sares$ dil)ted E,

Te 9%$%%% is added to net income beca)se te con*ersion is ass)med to occ)r at te beginning of te (eriod so tere +o)ld be no di*idends (aid o)t, T)s 9%$%%% +o)ld be

added bac$ 5)st lie +en after6ta. income is added bac +en calc)lating te dil)tionof con*ertible bonds$ +ic +e +ill go o*er ne.t,

If*onverted (ethod for onvertible DebtTe if6con*erted metod is a((lied tocon*ertible debt as +ell, After6ta. interest on te con*ertible debt is added to net incomein te n)merator$ and te ne+ common sares tat +o)ld be iss)ed at con*ersion areadded to te denominator,

-or a com(any +it net income of &%$%%%$%%% and 9%%$%%% +eigted a*erage commonsares o)tstanding$ basic E, Ass)me tecom(any also as &%%$%%% of 9: con*ertible bonds tat are con*ertible into &9$%%%

sares$ and te ta. rate is 3%:, /sing te if6con*erted metod$ dil)ted ER = P9%%$%%% Q &9$%%%R>,

7ote te after6ta. interest on con*ertible debt tat is added to net income in ten)merator is calc)lated as te *al)e of te interest on te con*ertible bonds ;&%%$%%% .9:>$ m)lti(lied by te ta. rate ;&6,3%>, ;-or more e.am(les see o)r C-A Le*el & St)dy)ide Calc)lating Basic and -)lly il)ted E

&reasur# Stock (ethod Te treas)ry stoc metod is )sed to calc)late dil)ted E, Te sare co)nt +o)ld increase by 8$%%% ;&%$%%% 6 $%%%> beca)se after te $%%% sares are re()rcased tere is still a 8$%%% sare sortfall tatneeds to be created,

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Sec)rities can be anti6dil)ti*e, Tis means tat$ if con*erted$ E


18/21

a com(any iss)es a bond +it co)(on (ayments tat are e1)al to te c)rrent maret rate$te bond is said to be iss)ed at (ar, -rom an acco)nting (oint of *ie+ tis means tat if acom(any iss)es a &" bond at (ar te com(any +ill in ret)rn a*e raised &" in ca(italfor its efforts,

0en bonds are iss)ed +it co)(on (ayments tat are not e1)al to te c)rrent maretinterest rate tey are considered to be iss)ed at a F(remi)mF or Fdisco)ntF to or from (ar,Com(anies tat are *ery acti*e in bond iss)ance iss)e bonds at (ar more fre1)ently tantose com(anies tat are not as acti*e,

%&a!ple of bonds issued at a discount' Com(any ABC iss)es a bond tat +ill (ay : ayear for fi*e years and similar bonds trading are c)rrently (aying &%:,0ile tere arem)lti(le maret related factors tat determine te iss)ing (rice ;s)((ly and demand$credit ratings$ analysts' o(inions$ state of te economy and yield c)r*e caracteristics>$ intis sim(listic e.am(le te bonds +o)ld most lie be iss)ed at a disco)nt to its (ar *al)eto com(ensate for te lo+er co)(on (ayments, Te com(any +ill )ltimately get less

money for its bond tan te stated (ar *al)e$ and te bonds are said to sell at a disco)nt,

%&a!ple of bonds issued at a pre!iu!'Com(any ABC iss)es a bond tat +ill (ay &%: ayear for fi*e years and similar bonds are c)rrently (aying :, Te only +ay te com(any+ill sell tis bond to in*estors is if te com(any sells te bond at a (remi)m to its (ar*al)e ;for more money> to com(ensate te com(any for te (aying a iger co)(on, Tecom(any +ill )ltimately get more money for its bond tan te stated (ar *al)e$ and te bond is said to sell at a (remi)m,

-rom an acco)nting stand(oint$ a com(any tat sells a bond at a disco)nt ;or (remi)m>+ill record on a cas basis a smaller interest (ayment b)t in reality +ill a*e a iger

interest e.(ense beca)se it recei*ed fe+er dollars for its bond, In accordance +it tematcing (rinci(le$ (remi)m and disco)nts m)st be amortiGed o*er te life of te bond,/,S, AA< allo+s com(anies to amortiGe (remi)ms or disco)nts by )sing a straigt6lineamortiGation or te effecti*e interest rate metod,

Discount vs6 Premium Pricing

If co)(on maret rate$ te bond is iss)ed at (ar,

If co)(on maret rate$ te bond is iss)ed at a (remi)m, Te iss)ing com(any +ill getmore money at initiation tan it +ill (ay to in*estors at mat)rity, In e.cange it +ill (ay aiger co)(on tan it +o)ld a*e to if te bond +as iss)ed at (ar,

If co)(on maret rate$ te bond is iss)ed at a disco)nt, Te iss)ing com(any +ill getless money at initiation tan it +ill (ay to in*estors at mat)rity, In e.cange it +ill (ay alo+er co)(on tan it +o)ld a*e to if te bond +as iss)ed at (ar,

Effects of Debt Issuance

Iss)ing debt im(acts a com(any's financial statements differently de(ending on if te bonds are iss)ed at (ar$ at a (remi)m or at a disco)nt,


19/21

-onds Issued at Par * Effects !n:

• Income statement * Te income statement +ill incl)de an interest e.(ense e1)al

to te bond's co)(on (ayment attrib)table to te s(ecified acco)nting (eriod,• -alance sheet * Te balance seet +ill incl)de at all times a long6term liability

e1)al to te face *al)e of te bond )ntil its mat)rity or redem(tion,• ash flow statement * oing for+ard$ cas flo+ from o(erations +ill incl)de te

interest e.(ense recorded on te income statement, As of te iss)ing date$ tecom(any +ill acco)nt in cas flo+ from financing te total amo)nt recei*ed forte bond,

-onds Issued at a Premium * Effect !n:


to te bond's co)(on (ayment min)s te amortiGed (ortion of te (remi)mrecei*ed d)ring te s(ecified acco)nting (eriod,

•

-alance sheet * Te balance seet +ill incl)de at all times a long6term liabilitye1)al to its carrying *al)e, At initiation te carrying *al)e +ill be e1)al to te face*al)e of te bond (l)s te total )namortiGed (remi)m, E*ery year te bond *al)erecorded on te balance seet +ill be red)ced )ntil te bond comes to mat)rity oris redeemed$ and te bond *al)e dis(layed on te balance e*ent)ally reaces te bond's original face *al)e,

• ash flow statement * oing for+ard$ cas flo+ from o(erations ;C-O> +ill

incl)de te act)al co)(on (aid to te debt older d)ring te s(ecified acco)nting (eriod, Since tis is a bond tat +as sold at a (remi)m$ it is (aying o)t a largerco)(on tan is c)rrently stated as an interest e.(ense on te income statement, Asa res)lt$ C-O +ill be )nderstated relati*e to tat of a com(any tat sold its bond at

(ar, Te amortiGed (ortion of te bond (remi)m +ill be incl)ded in cas flo+from financing, Tis +ill ca)se te re(orted cas flo+ from financing to beo*erstated relati*e to tat of a com(any tat sold its bond at (ar,

-onds Issued at a Discount * Effect !n:


to te bond's co)(on (ayment (l)s te amortiGed (ortion of te disco)nt recei*edd)ring te s(ecified acco)nting (eriod,

• -alance sheet * Te balance seet +ill incl)de at all times a long6term liability

e1)al to its carrying *al)e, At initiation te carrying *al)e +ill be e1)al to te face

*al)e of te bond min)s te total )namortiGed disco)nt, E*ery year te bond*al)e recorded on te balance seet +ill be increased )ntil te bond comes tomat)rity and te bond *al)e dis(layed on te balance is e1)al to te bond's face*al)e,

• ash flow statement * oing for+ard$ cas flo+ from o(erations +ill incl)de te

act)al co)(on (aid to te debt older d)ring te s(ecified acco)nting (eriod,Since tis is a bond tat +as sold at a disco)nt$ it is (aying o)t a smaller co)(ontan is c)rrently stated as an interest e.(ense on te income statement, As a res)lt


20/21

C-O +ill be o*erstated relati*e to tat of a com(any tat sold its bond at (ar, TeamortiGed (ortion of te bond disco)nt +ill be incl)ded in cas flo+ fromfinancing, Tis +ill ca)se te re(orted cas flo+ from financing to be )nderstatedrelati*e to tat of a com(any tat sold its bond at (ar,

omputationCom(any ABC iss)es a &" bond tat +ill (ay a &%: semiann)al;co)(on> for tree years te com(any +ill generate 9%%$%%% EBITA o*er te ne.ttree years, Contract te effect if maret rate at te time of iss)ance +as &%:$ &&: and:, ;Straigt6line de(reciation is )sed for (remi)ms and disco)nts>, Ta.es are notconsidered,

!pening -alance Sheet

;-or more on tis s)b5ect$ read Im(lications Of ebt Iss)ance,>

Investors: Ask "h# the ompan# Issued 1ew Debt0en a com(any iss)es ne+ long6

term debt$ it's im(ortant for in*estors to )nderstand te reason, Com(anies so)ld gi*ee.(lanations of ne+ debt's s(ecific ()r(ose rater tan *ag)e boiler(late s)c as Fit +ill be )sed to f)nd general b)siness needs,F Te most common ()r(oses of ne+ debt incl)dete follo+ing@

&, To -)nd ro+t 6 Te cas raised by te debt iss)ance is )sed for s(ecificin*estment;s>, Tis is normally a good sign,

2, To Definance FOldF ebt 6 Old debt is retired and ne+ debt is iss)ed$ (res)mablyat a lo+er interest rate, Tis is also a good sign$ b)t it often canges tecom(any's interest rate e.(os)re,

3, To Cange te Ca(ital Str)ct)re 6 Cas raised by te debt iss)ance is )sed to

re()rcase stoc$ iss)e a di*idend or b)yo)t a big e1)ity in*estor, e(ending onte s(ecifics$ tis may be a (ositi*e indicator,

8, To -)nd O(erating 7eeds 6 ebt is iss)ed to (ay o(erating e.(enses beca)seo(erating cas flo+ is negati*e, e(ending on certain factors$ tis moti*e may bea red flag, Belo+$ +e loo at o+ yo) can determine +eter a com(any isiss)ing ne+ debt to f)nd o(erating needs,

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-e areful of Debt that 5unds !perating 1eeds/nless te com(any is in te earlygro+t stage$ ne+ debt tat f)nds in*estment is (referable to debt tat f)nds o(eratingneeds, To )nderstand tis toro)gly$ recall from te cas flo+ installment tat cangesin o(erating acco)nts ;tat is$ c)rrent assets and c)rrent liabilities> eiter (ro*ide orcons)me cas, Increases in c)rrent assets 6 e.ce(t for cas 6 are F)ses of cas,F Increases

in c)rrent liabilities are Fso)rces of cas,F Consider an abridged *ersion of Deal 7et+ors' balance seet for te year ending ec 3&$ 2%%3@

-rom ec, 2%%2 to ec, 2%%3$ acco)nts recei*able ;a c)rrent asset> increaseddramatically and acco)nts (ayable ;a c)rrent liability> decreased, Bot occ)rrences are)ses of cas, In oter +ords$ Deal 7et+ors cons)med +oring ca(ital in 2%%3, At tesame time$ te com(any iss)ed a &%% million con*ertible bond, Te com(any'scons)m(tion of o(erating cas and its iss)e of ne+ debt to f)nd tat need is not a goodsign, /sing debt to f)nd o(erating cas may be oay in te sort r)n b)t beca)se tis isan action )ndertaen as a res)lt of negati*e o(erating cas flo+$ it cannot be s)stainedfore*er,

MO! "TI #!$ I% T&I$ O##! TIO%

Insigts cannot o*erla( and m)st be se(arate from oter igligts,
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