chapter 8 note - Chapter 8 Common Stock By Dr. M....

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1 Chapter 8 Common Stock By Dr. M. Metghalchi Common stock Common stockholders bear the residual risk of a corporation’s cash flows. Common stockholders have the right to the residual income and assets after bondholders and preferred stockholders have been paid. Common stockholders elect the firm’s board of directors Firms may have different classes of stock with different voting rights Shareholders have limited liability if the firm elects to default on its debt. The liability is limited to the amount of their investment in the firm. Dividend payments to shareholders are not tax deductible. Shareholders have the right to share in stock offerings: preemptive right entitles the Common stockholders to maintain a proportionate share of the ownership in the firm. Generally, the bondholder and preferred stockholder are promised a fixed amount each year; however the dividend for common stock is based on the profitability of the firm and can vary from time to time according to management's decision either to pay dividends or increase it or decrease it. Common stock’s intrinsic (theoretical) value is equal to the present value of all future cash flows expected to be received by the stockholder. The pre-emptive right is the right of stockholders to maintain their proportionate ownership in the firm. If the firm seeks to raise more funds through the sale of common stock, these shares must initially be offered to existing stockholders. If these stockholders buy the additional shares, their proportionate ownership is maintained. Cumulative voting is a means by which a minority may obtain representation on the corporation's board of directors. It permits an investor to cast all of his or her votes for one candidate instead of having to spread those votes for each seat. Thus, if an investor owns 100 shares and the corporation has five seats, the investor may cast the entire 500 votes for one candidate instead of casting 100 votes for a candidate for each of the five seats.
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2 Management tends to increase cash dividends after earnings have increased, and it believes the higher earnings will be maintained. Since the reluctance to cut dividends encourages management to follow a conservative policy on dividend increments. Management may continue to maintain cash dividends even when earnings decline if the firm has the funds and management believes the decline in earnings will be temporary. Stockholders, who own stock on the date of record, receive the dividend. Since it takes three days for settlement, the investor must own the stock three days prior to the record date to be eligible to receive the dividend. The ex-dividend day is the first day of trading exclusive of the dividend. Investors who purchase the stock on the ex-dividend day do not receive the dividend. The distribution date establishes when the dividends are to be received by stockholders. Dividend reinvestment plans permit investors to acquire additional shares before the
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This note was uploaded on 09/21/2011 for the course FINANCE 4320 taught by Professor Omaral-nasser during the Spring '11 term at University of Houston-Victoria.

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chapter 8 note - Chapter 8 Common Stock By Dr. M....

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