Applied Managerial Finance (Essay Sample)

TOPIC: APPLIED MANAGERIAL FINANCE
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INTRODUCTION:
The cost of equity of a firm represents the compensation the market demands in exchange for owning the asset and bearing the risk of ownership. Equity issuance is the sale of new stock to investors. Equity issuance can be achieved through a public or private sale. A public sale involves firms registering their securities with relevant authorities. Sales are done in a public and organized market. The sale is open to all interested and registered investors. Examples of public equity issuance are Secondary equity offerings and Initial public offerings. In private sale, the transaction between the firm and the investor takes place directly. It does not involve many investors.
The advantages of issuing equity are, there is a borrowing base. This can be finished by giving out shares. This increases the financial capability of a company because it can borrow additional funds when needed. Lenders give money that is proportional to a company’s equity capital. (Block, 2009)A company also has permanent capital since the shares are not redeemable. The company thus has capital to run the company as long as it is in operation. Another advantage is dividend payment discretion. In difficult times, a company may suspend paying dividends and this will stop cash outflow, which may lead to the collapse of a company.
The disadvantages of issuing equity are as follows: High cost of shares brought by high flotation costs on ordinary shares. There is a risk in terms of dividends and capital gains. An investor will thus hesitate to put his or her money in a company undertaking equity issuance. Earnings dilution occurs when new ordinary shares reduces the earnings of current shareholders. Ownership dilution is a major disadvantage. It occurs when the current shareholders do not have funds to buy additional shares. (Brigham, 2004)
An initial public offering occurs when a company sells its shares to the public for the first time. A company may sell few shares while others sell all the shares. IPOs normally occur during the transition from public to private. The advantages of IPOs are, it provides a new source of funds for a company and it allows companies to take part in mergers and acquisitions. (Block, 2009)There are disadvantages of IPOs such as fluctuation in stock values and high costs of IPOs. For an initial public offering to occur the following conditions must be met: The state of the stock market must be considered. It is advisable for an IPO to be done when the stock market is good and there is inflow of cash. An IPO should not be done when the stock market is declining since at this time there is limited capital at the stocks market. The market should be receptive to the IPOs. Some of the indicators of a receptive market include the willingness of investors to accept new companies in the market and the ability of the firm to make more returns. (Brigham, 2004)