Equity holder

Equity holders require a real return on their outlay, which they assume to be at the stock-market price if this differs from the face value of the stock, of 7 percent net of all taxes. Retained earnings attract a 40 percent capital gains tax hence the actual interest rate required on distribution forgone is 7/(1 — 0.40) = 11.67 percent. This is in real terms and at a time of 8 percent inflation rate must be increased in cash terms to (1 -I- 0.1167)(1.08) — 1 = 20.60 percent. 

Furthermore it is not just submarine patents on IP that can cause problems. There may also be issues relating to manufacture, obligations secured against product rights which may include leases, covenants for loan guarantees and similar structures which can lurk in a company behind a product as an unseen liability. In certain cases a product or other assets of a company may not even be divested without the permission of a financial institution or equity holder who holds such a covenant or lien. This can mean a requirement to make a settlement with that institution outside the terms of an acquisition and can add considerably to the costs of a transaction both in time and in money. 

When considering equity transactions some of the most significant issues to be considered are the valuation of the shares offered at the time of the offer and then at that date of closing which can vary, sometimes quite widely. Another factor which can have a bearing on the attraction of an equity transaction are the requirements for lock-up periods where shares cannot be traded for a defined time following the closing of the transaction. This can be a serious concern to private equity holders as there is an unknowable quantity of risk implied by waiting for the lock-up period to end and this will induce a very cautious approach to valuation as a result. Furthermore the ownership structure of a... 

The central financial assumption for the calculation of second generation leve-lized PV electricity and H2 prices is the assignment of the depreciated 10% value of first generation assets as the second generation investment value for equity holders. All other second generation capital investments, revenues, expenses, depreciation, and taxes are entered into the net present value cash flow model in exactly the same manner as the first generation model. The capital structure of H2 production and distribution firms is assumed to remain 30% equity and 70% debt. The rate of return on equity remains 10%, the rate of return on debt remains 7%, the income tax rate remains 39%, and the discount rate remains 6%. 

At the heart of the Merton s assumptions, equity holders have an embedded put option by which if at maturity the firm value is greater than promised obligation ox face value, the lender gets back the bond s amount and shareholder maintains the ownership of the company otherwise, if the firm value is lower than the promised payment, the bondholders receive an amount less than bond s face value and the firm defaults. Therefore, in the case of high-put option value, shareholders will have an advantage to walk away from the loan payment, leaving the asset value to the bondholders. 

Finally, Merton s model assumes that when the value of firm is lower than the value of debt, equity holders sell assets in order to fulfill their... 

The timing, as well as extent, of defaults is critical to equity return. As a general matter, equity holders receive a significant part of their return early in the life of a transaction. This is because the initial excess spread tends to be highest given that defaults are unlikely to occur until later on in the deal s life. The later in a CDO s life that defaults occur, the less the return to the equity holder will be affected. Examples of equity returns patterns and their sensitivity to default will be demonstrated later in case studies. 

The static, no-loss return of the various tranches in this case might have the profile shown in Exhibit 22.6. Here the equity tranche constitutes the first 50 million of risk, and is compensated for its position in the capital structure with a very high notional spread of 20.5%, or 10.25 million per year on 50 million notional. This spread represents the annual return to the equity holder in the scenario where no losses are incurred. Conversely, the most senior tranche of risk receives only 1.05 million per year on a notional position of 700 million. The low spread return of only 15 bps ( 1.05 million/ 700 million) underscores the perceived safety of the super-senior tranche. 

In fact, the position of the 5% funded equity holder is exactly equivalent to an investor that has purchased 1 billion of assets with 20 times the nonrecourse leverage. The implied borrowing rate of such leverage is equivalent to the blended spread of the tranches that are senior to the equity. In our case the premiums due to the three tranches above the equity total 4.75 million, and the total tranches of risk that they represent equal 950 million. The annual spread due is 0.50% of the notional on these liability tranches and, thus, in this case the equity holder has borrowed 950 million at a blended borrowing cost of 50 bps. 

With this analysis, the synthetic CDO looks much like any operating company, as shown in Exhibit 22.7. The equity holders have purchased assets of 1 billion. Those assets are predicted to generate a return of 15 million (the asset spread ). To purchase those assets, the equity holders have put up 50 million, and borrowed 950 million. They must pay 4.75 million per year in a regate (the liability spread ) to service their debt, and if it all goes bad they will not lose any more than the 50 million that has been put up. Any losses in excess of this amount will begin to accrue to other tranches according to predetermined rules, which are discussed below. 

Recovered asset payment to equity holder + 3,000,000 Remaining equity tranche, post-loss 43,000,000... 

However, the very flexibility of synthetics mean that there are a variety of other important decisions to be made regarding the allocation of cash flows. For example, in a traditional structure, the equity holder in our deal would undergo what is shown in Exhibit 22.9 upon the experience of a loss. The tranche size is reduced by the amount of the loss. The coupon will remain at the same spread, but the spread will be paid only on the reduced notional amount. 

If the underlying portfolio performs well and its loss profile is more attractive than projected, because of better-than-expected default and recovery rates, the return to the equity holder after payments to the senior and junior tranche will be higher than expected. If, however, the underlying portfolio performs poorly and default and recovery rates are worse than projected, perhaps because of adverse economic conditions, the tranche returns will be lower than expected. Poor investment management will also have an adverse impact on the return to investors. 

The entries arc in alphabetical order, and no attempt has been made by the authors to be restrictive in any entry. Under the heading company ownership", mention is made of major ownership by another company, or of the existence of major equity holders. Otherwise, ownership is assumed to be private or public share ownership, according to the type of company. 

Net income differs when comparing two companies with identical operating performance that carry different amounts of debt. The company with more debt would show a lower net income. Remember that net income is the profit only available to equity holders. 

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