FINC5001_Cpital Markets Corporate Finance_2009 Semester 1_Week 13 FINC 5001 Tutorial Solutions.docVIP

FINC 5001 Capital Markets and Corporate Finance Tutorial Questions and Solutions Week 13 – Capital Structure Policy DQ 1 A company wants to raise $100 million by issuing shares over the next 12 months. Discuss the different methods available to the company for raising equity finance. Be sure to identify the possible risks and costs. Answer There are four avenues by which the company can raise $100 million in equity finance: (1) Initial Public Offering (IPO) (2) Rights Issue (3) Dividend Reinvestment Plan (DRP) (4) Private Placement. An IPO involves listing the company on a recognised stock exchange (e.g. the ASX) for the first time. In order to become listed the company needs to comply with the exchanges listing rules and prepare a prospectus that outlines the details of the offer including the price and number of shares on offer, and provides financial and general information about the company. The main costs involved in an IPO include the underwriting/advisory fees, prospectus costs, listing fees, printing and postage, advertising and share registry fees. The risks involve under-subscription (only relevant if no underwriter exists), incorrect setting of the issue price, which leads to an opportunity cost to the company and perhaps legal action by investors. A rights issue raises additional capital by giving existing shareholders the right to purchase new shares in the company in proportion to the number of shares held for a pre-specified price. The ‘right’ does not represent an obligation and can be renounceable, which means that they can be sold to third parties by the recipient shareholder. A rights issue also involves the preparation of a prospectus and hence the associated costs (similar to those of an IPO). The risk associated with a rights issue is a dilution of the share price below its theoretical ex-rights price. Dividend reinvestment plans (DRPs) give shareholders the option of receiving new shares instead of dividends. DRPs i