Podcast
Questions and Answers
Why might a company's announcement of a seasoned equity offering (SEO) lead to a decline in its stock prices?
Why might a company's announcement of a seasoned equity offering (SEO) lead to a decline in its stock prices?
- Because SEOs increase the firm's debt capacity, making it less attractive to investors.
- Because SEOs always dilute existing shareholder equity, regardless of market conditions.
- Due to the perception that managers are issuing shares when the stock is overpriced, signaling potential overvaluation based on private or insider information. (correct)
- Due to increased demand from investors anticipating higher future dividends.
From the perspective of investment analysts, a company issuing new shares when its current share price is exceptionally high is always a sign of financial distress.
From the perspective of investment analysts, a company issuing new shares when its current share price is exceptionally high is always a sign of financial distress.
False (B)
List two critical implications (effects) when a firm is considered highly leveraged after issuing shares.
List two critical implications (effects) when a firm is considered highly leveraged after issuing shares.
- A drop in earnings due to increased financial leverage. 2. A rise in the shareholders' required rate of return due to increased financial risk.
The cost of issuing securities, also known as '______ cost', is a key factor in stock valuation and includes expenses like filing and legal fees.
The cost of issuing securities, also known as '______ cost', is a key factor in stock valuation and includes expenses like filing and legal fees.
Match the following expenses with their type related to the cost of new issuance:
Match the following expenses with their type related to the cost of new issuance:
Which of the following best describes 'asymmetric information' in the context of a company announcing a seasoned equity offering?
Which of the following best describes 'asymmetric information' in the context of a company announcing a seasoned equity offering?
An increase in a firm's financial leverage always leads to an increase in its stock price.
An increase in a firm's financial leverage always leads to an increase in its stock price.
Explain why the market might react skeptically when a company announces a seasoned equity offering.
Explain why the market might react skeptically when a company announces a seasoned equity offering.
Opportunity costs, such as management time spent working on the new issuance, are examples of ______ expenses associated with the cost of new issuance.
Opportunity costs, such as management time spent working on the new issuance, are examples of ______ expenses associated with the cost of new issuance.
Which of the following is NOT a factor contributing to a potential decrease in the overall value of a firm after a new issuance?
Which of the following is NOT a factor contributing to a potential decrease in the overall value of a firm after a new issuance?
Flashcards
Seasoned Equity Offering (SEO)
Seasoned Equity Offering (SEO)
When a company offers additional shares after its initial public offering (IPO).
Asymmetric Information
Asymmetric Information
Information that is private or known only to company insiders, not available to the general public.
Market Skepticism after SEO
Market Skepticism after SEO
Skepticism arises when new shares issue with high prices.
Exhausted Debt Capacity
Exhausted Debt Capacity
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Cost of New Issuance
Cost of New Issuance
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Direct Expenses (New Issuance)
Direct Expenses (New Issuance)
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Legal Fees (New Issuance)
Legal Fees (New Issuance)
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Indirect Expenses (New Issuance)
Indirect Expenses (New Issuance)
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Study Notes
- When a company announces a seasoned equity offering, there is often a notable decline in its stock prices
- This decline is commonly attributed to private, or insider information known by the managers, referred to as asymmetric information
- This information is not available to the general public, and acts as a signal to the market
- From the perspective of investment analysts and investors, there is a perception that company managers may be attempting to issue new shares when the current share price is exceptionally high or overpriced
- This perception leads to skepticism among the public, therefore anticipating a decrease in stock prices
- On the other hand, the market tends to conclude that the issuing firm might have exhausted its debt capacity
- In financial terms, when the firm is considered highly leveraged, this leads to two critical implications: an increase in the firm's financial leverage, causing a drop in earnings, and a higher financial risk causing a rise in the shareholders' required rate of return
- Consequently, these factors contribute to a decrease in the overall value of the firm
The cost of new issuance
- The cost of issuing securities can be referred to as underwriting cost or floatation cost in stock valuation
- It can be determined by looking at the direct and indirect expenses
Direct expenses
- Direct expenses include filing fees which are the cost of getting all that paperwork in order
- Legal fees are the costs associated with hiring lawyers and auditors to ensure everything is done according to the law
Indirect expenses
- Indirect expenses mainly include opportunity costs like management time spent working on the issue
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