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FINC206 > 206 > Flashcards

206 Flashcards

1
Q

Corp finance 3 key words

A

what to invest in
how to fund it
how to manage it

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2
Q

investing is all about

A

budgeting what to invest it

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3
Q

how to fund it is about

A

raising cap with d/e

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4
Q

how to manage it is about

A

managing CA/CL

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5
Q

agency issues is when

A

principles (stockholders) and agents (managers) interests not aligned

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6
Q

what causes agency issues

A

sep of control and ownership

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7
Q

agency costs are

A

losses to shareholders wealth

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8
Q

mitigate agency issues by

A

external audits, pay reviews

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9
Q

TVM is not

A

linear

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10
Q

CAGR

A

compound annual growth rate

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11
Q

What is CAGR?

A

investments annual growth rate over a given period

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12
Q

For NPV what is the minimum price sell

A

NPV not including initial cost

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13
Q

for NPV, a higher r means

A

lower NPV and higher risk

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14
Q

What does a flat term structure mean?

A

r constant

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15
Q

advantages of NPV (2)

A
  • includes TVM
  • looks at all cash flows
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16
Q

IRR assumes

A

all future CFs are reinvested at IRR

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17
Q

how to work out the inflection point of 2 projects

A

A-B for each CF (or B-A)

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18
Q

IRR advantages

A

easy

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19
Q

IRR disadvantages (5)

A

doesn’t account for TVM
doesn’t distinguish financing vs investment
might not exist/ might have multiple
assumes term structure is flat
size/scale/timing of mutually exclusive

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20
Q

IRR rules for investing

A

if -CFS front loaded invest if IRR>r
if -CFS back loaded invest if IRR<r

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21
Q

investment vs financing projects

A

investment
- more conventional/traditional
- buy now, generate CFS
financing
- less conventional
-receive loan today, pay later
-already set up

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22
Q

investment vs financing projects

A

investment
- more conventional/traditional
- buy now, generate CFS
financing
- less conventional
-receive loan today, pay later
-already set up

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23
Q

A higher IRR means

A

more return, more efficient

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24
Q

What’s scaling?

A

scaling up the more efficient project

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25
Q

Modified IRR 3)

A

Discounting
Reinvestment
Combination

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26
Q

Discounting MIRR

A

discount -Cfs back to 0 and = to Initial cost

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27
Q

Reinvestment MIRR

A

put all cfs (not CF0) to end of project

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28
Q

Combination MIRR

A

discount -Cfs back to 0 and = to ICost and pt all cfs not CF0 forward to end

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29
Q

Independent projects

A

Choose any

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30
Q

Mutually exclusive

A

rank/choose 1

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31
Q

When does NPV and IRR not give the same decision?

A

non-conventional CF
mutually exclusive where IC and timing of CFs are VERY different

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32
Q

Payback period advantages

A

easy
favors liquidity

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33
Q

disadvantages of the payback period

A

subjective
bias towards higher CFs early on
ignores some CFs and TVM
NPV could be -

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34
Q

Profitability index

A

ratio between generation of Cfs vs generation of cost

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35
Q

Advantages of PIndex

A

when initial investment is limited
easy
correct if independent
accounts TVM

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36
Q

Disadv of PIndex

A

problems with mutually exclusive
ignores higher NPV

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37
Q

Capital budgeting decision is the

A

investment in NCA

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38
Q

3 key parameters of FCFs

A

size, timing, risk

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39
Q

finance vs accounting cfs

A

Finance
- valuing a CFs
- what is it, timing, risk
-where are we going?

Act
- what happened, where are we now?
- place to start

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40
Q

Revenues, Costs and Depreciation contribute (+/-) to CFs

A

+-+

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41
Q

$1 increase in x (inc/decr) CF

A

inc r, inc cf
inc c, decr cf
incr dep, incr cf

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42
Q

Depreciation is not

A

a real CF

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43
Q

Depreciation is a ___ because

A

tax shelter because it reduces taxable income

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44
Q

EBT

A

Earning before tax
R-FC-FC-Dep

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45
Q

Tax

A

EBT x TR

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46
Q

EAT

A

EBT- Tax

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47
Q

OCF

A

EAT + dip

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48
Q

NWC

A

cash to run day-to-day
not consumed but employed

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49
Q

increase in WC is an

A

outflow because it is tied up and cannot be used anywhere else and does not make any returns

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50
Q

NWC is in

A

inventory on books

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51
Q

Income tax is a

A

cash outflow

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52
Q

Book value

A

is how much you can sell for from IRR

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53
Q

a positive externality is a

A

synergy and increases CF of the project

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54
Q

a negative externality is a

A

erosion and decreases CF of the project

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55
Q

change in NWC

A

NWC yesterday - NWX today

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56
Q

nominal

A

actually generated without impact of inflation

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57
Q

real

A

Cfs with adjustment for inflation

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58
Q

inflation

A

increasing prices in economy, when basket of goods (CPI) increases

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59
Q

What’s wrong with mutually exclusive projects with different lives?

A

NPV may not be accurate as to where the big CFs fall

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60
Q

Ways to even out project lives

A

Lowest common multiple life
NPV perpetuity
Equivalent Annual Annuity

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61
Q

LCM life

A

extend/replicate out to lowest common life

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62
Q

NPV perpetuity assumes

A

assumes both chains of replacement continues forever

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63
Q

EAA, EAC, EAV

A

Equivalent annual annuity, equivalent annual costs, equivalent annual value

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64
Q

PVIFA

A

PV interest factor annuity just short version of the annuits of CFS

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65
Q

Do you want higher/lower EAV, or EAC?

A

high EAV, low EAC

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66
Q

LCM, Perp, EAA rules have identical returns and diff

A

identical, all 3 give the same
diff, NPV perp is best
NPV perp and LCM give diff and EAA not appropriate

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67
Q

2 types of uncertainty

A

Direct
- binary
- diffuse
Indirect

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68
Q

Direct uncertainty-binary, diffuse

A

binary is competition investment
diffuse, consumer demand or cost of inflation

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69
Q

indirect

A

financial markets/access to cap

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70
Q

Sensitivity analysis

A

effect on NPV while changing one variable and holding the others constant

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71
Q

Sensitivity analysis

A

effect on NPV while changing one variable and holding the others constant

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72
Q

a changing variable for sensitivity analysis could be

A

market size

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73
Q

Scenario analysis

A

effect on NPV of a particular combination of assumptions

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74
Q

Accounting break even

A

sales which net profit=0

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75
Q

Finc break even

A

sales when NPV=0

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76
Q

Accounting vs finc break-even point for NPV

A

accounting NPV=(-)
finance NPV=0

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77
Q

finc break-even IRR

A

= r required

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78
Q

marginal cost

A

cost to produce 1 more unit

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79
Q

marginal cost is the same as

A

variable cost

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80
Q

what does the monte carlo simulation do?

A

models real-world uncertainty

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81
Q

steps of monte carlo simulation

A

-est cf that could occur (from given distrib and og CF) then use that to calc NPV and it does this 100 times then models them to see the sitribution of what the NPV could look like

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82
Q

financial option

A

owner has the right but not the obligation to buy something in the future for the price set today
e.g having the option to wait and invest when CFs get bigger

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83
Q

Real options

A

opportunities to vary the nature or longevity of the project
expand, abandon, delay

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84
Q

real options analysis disadvantages

A

complicated and complex to communicate with managers/shareholders
lots of theories/assumptions
could increase agency problems

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85
Q

decision trees are good because

A

they are graphical, so easy to understand

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86
Q

Total value of assets is

A

current assets + fixed assets (tang and intangible)

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87
Q

Total value of firm to investors

A

current liabilities, long-term debt, shareholders equity

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88
Q

Capital structure is made up of?

A

debt, equity

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89
Q

Goal of capital structure mix is to find the mixture that

A

minimizes WACC, maximizes firm value

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90
Q

A=

A

E+L

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91
Q

Value of a firm

A

D+E

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92
Q

Accounting vs finc approach for valuing a firm

A

acct:
on a ledge D+E=Value
finc:
V=PV of all CFs

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93
Q

Business risk

A

possibility profits could be lower
equity risk arising from firms operating activities

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94
Q

business risk does not inc

A

financing effect

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95
Q

business risk is influenced by

A

numerous factors (competition, demand, govt policy)

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96
Q

financial risk

A

equity risk from financial policy (cap structure)

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97
Q

financial risk means and a

A

additional risk on shareholders as a result of financial leverage

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98
Q

financial risk depends only on

A

type of securities issued

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99
Q

financial leverage

A

use of debt

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100
Q

Advantages of leverage

A
  • higher return on equity
    -higher variability in return equity
    -increases opportunities
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101
Q

Net income

A

EBIT-Interest

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102
Q

EPS

A

NI/Shares number

103
Q

ROE

A

NI/E

104
Q

ROAss

A

EBIT/Assets

105
Q

equity is the

A

claim on future earnings of a company

106
Q

equity is the

A

claim on future earnings of a company

107
Q

With debt if earnings are good…

A

we perform better than without

108
Q

if EBIT<BE pt

A

lev not helpful

109
Q

what must happen for leverage to increase ROEq? why?

A

ROA>Rb
the company needs to earn more from its assets (ROA) than it pays in interest on its deb

110
Q

homemade leverage is the

A

use of personal borrowing/lending to alter leverage

111
Q

homemade leverage means s..

A

shareholders can adjust the amount of financial leverage by borrowing/lending on their own

112
Q

2 portfolios can have

A

un lev firm, lev ourselves
lev firm, risk free rate

113
Q

capital structure assumptions

A

perfect markets
homogenous expectations, business risk classes
perpetual CFs

114
Q

MM proposition 1 is all about

A

valuation

115
Q

MM Prop 1

A

cap structure is independent in determining value of firm

116
Q

MM Prop 1 equation

A

Vu=Vl

117
Q

MM1 Prop is saying

A

in an efficient market, investors can just replicate perfectly the CFs between 2 different assets, if they do that the prices must be consistent with the price to replicate

118
Q

MM1 Prop means firm A

A

can just borrow to match the cap structure of firm B

119
Q

MM1 Law of one price

A

investor pays the same price for identical CFs

120
Q

MM1 means for WACC

A

that it is constant across all levels of lev

121
Q

MM Prop 2 is all about

A

cost of capital

122
Q

MM2 is that

A

required Re arises from sources of firm risk

123
Q

debt increases what type of risk? u/s?

A

systematic which is market risk

124
Q

What happens to ROEq when lev increases?

A

increases as shareholders need more compensation

125
Q

why are interest payments lit comp to divs?

A

they are tax deductible where as divs are not

126
Q

more interest means,

A

less taxable income

127
Q

with taxes taken into account what is the value of a levered firm

A

Vl=Vu+tB

128
Q

in a no tax world and markets are efficient what does this mean for us?

A

investors can arbitrage and prices sort themselves out, Vu=Vl, which means WACC is constant, this means cost of eq increases and then financial risk increases, business risk increases

129
Q

in the tax world due to the tax shield what happens to cost of debt

A

cost of debt decreases, WACC decreases and hence, firm value increases

130
Q

WACC is the

A

cost of capital and it reflects how the firm is funded

131
Q

Critique for MM

A

personal tax disadvantages of debt makes corporate tax advantages ineffective
borrowers incur costs (bankruptcy and agency costs) which offset value on interest tax shield

132
Q

Bankruptcy is when __ much of the firm is in debt

A

nearly 100%

133
Q

Direct and indirect costs of bankruptcy

A

direct: lawyer’s fees
indirect: loss of opportunities from business

134
Q

costs associated with bankruptcy affect firm value how?

A

lower

135
Q

agency costs of debt

A

conflict that arises between shareholders and debtholders

136
Q

3 selfish strategies of a stockholder within agency costs of debt

A

1) take larger risks
- Shareholders invest in NPV (-) that destroys the value of bondholders and boosts eq
2) underinvestment
- don’t want to invest their own money to boost debtholders
3) milking out
- takes eq money out in the form of more dividends leaving less for debt holders

137
Q

2 ways to decrease costs of financial distress

A

protective convenants
debt consolidation

138
Q

Protective convenants

A

+
keep biz running at min level
-
agreement for d/e holders to limit actions a firm can take (mergers)

139
Q

debt consolidation

A

taking out a loan to pay off debt

140
Q

static trade-off theory of capital structure

A

there is a trade-off between the tax advantage of debt and the costs of financial distress, only to a pt

141
Q

is there an optimal pt where cap structure max value, min WACC?

A

yes

142
Q

in a static world this an optimal __

A

B*

143
Q

optimal capital structure is __ and firm is __

A

static but dynamic

144
Q

taxes and bankruptcy costs are just

A

other claims on CFs of a firm, more pieces of pie

145
Q

Agency costs of d/e ratio

A

work harder with debt, less FCF (paid out as divs) for managers to waste

146
Q

Tax benefit and decreased agency costs of eq advantage of debt

A
  • int payments are tax deducible meaning less taxable income
  • Increased divs means less FCF for managers to waste
147
Q

bankruptcy costs and agency costs of debt disadvantage of debt

A
  • if firm cannot meet obligations then more financial distress
  • managers hurt bondholders and boost eq holders (selfish strategies)
148
Q

personal taxes mean eq income faces but int payments are

A

2x taxation (firms and shareholders)
only taxed individually

149
Q

MM and personal taxes mean that corporate tax benefits of

A

lev are partially offset by personal taxes

150
Q

2 special cases of personal tax

A

MM w/corp taxes Tps=Tpb so the gain from lev=Tcb
MM w/out corp taxes, gain lev=0

151
Q

classical tax system favors

A

corporate tax

152
Q

imputation tax system means

A

tc=0

153
Q

in terms of div payments imputation tax system means

A

you get tax credited with div payments as corp taxes already paid on income

154
Q

dividend imputation means what for debt?

A

debt becomes less attractivwe

155
Q

agency costs and information asymmetries and at announcement

A

if Veq<MVe then the market has overvalued so sell as earn more than what they are worth
then at announcement Ve<MVe so stock price decreases

156
Q

pecking order theory

A

retained earnings (internal)
debt
equity

157
Q

if internal CFs> capital investment

A

use surplus to pay debt

158
Q

debt ratio in pecking order theory

A

reflects the requirement for external financing

159
Q

pecking order theory is at odds with

A

trade-off theory

160
Q

EBIT does what when D increases

A

decreases

161
Q

3 ways to value a project with leverage

A

1) adjusted present value
2) flow to equity
3) wacc method

162
Q

APV incorporates

A

financing aspects

163
Q

3 main side effects of financing APV

A

tax subsidy of debt
costs of issuing new securities
subsidy to debt financing

164
Q

tax subsidy to debt APV means timeline-wise

A

borrow (+CF) year 0
pay int (-CF) years

165
Q

costs of issuing new securities APV means timeline-wise

A

pay floatation cost (-CF) year 0
receive tax shield (+CF) years

166
Q

costs of subsidy to debt financing APV means timeline-wise

A

borrow (+CF) year 0
pay int (-CF) years

167
Q

flow to equity is where you discount

A

CF from projects to eq holders of lev firm at cost of levered equity capital
Discount LCFs at Rs

168
Q

WACC method

A

discount UCF at WACC

169
Q

pure play firm ___ can be used for__

A

Similar firm B can be used as a proxy but needs to be adjusted for the leverage amount
can be used for non-scale enhancing project

170
Q

difference between long-term financing

A

ownership vs debt

171
Q

financing order

A

equity
debt
ret earnings

172
Q

financial deficit

A

difference between use of cash flow and internal financing

173
Q

debt financing summary

A

not owners
no voting rights
int payments tax deductible
legal abilities
Excess debt= financial distress
int payments inc in cost of doing business

174
Q

equity financing summary

A

ownership
voting rights
divs not tax deductible
divs not part of doing business costs
no legal claims
cannot go bankrupt

175
Q

indenture

A

contract

176
Q

collateral

A

financial securities or any asset pledged to the debt

177
Q

mortgage

A

secured by real property

178
Q

seniority

A

debt holders paid first

179
Q

covenants

A

restrictive clauses in a bond contract to limit issuer taking actions that could hurt bondholders

180
Q

bond covenant examples

A

issuing new debt, div/share repurchases, m and acq, asset disposition

181
Q

debenture

A

unsecured bond

182
Q

note

A

unsecured bond t<10

183
Q

registered

A

keeps initial record of who purchased bond and change of owners

184
Q

bearer bond

A

holder of bond=owner

185
Q

3 forms of debt financing

A

0 coupon, non-0 coupon
fixed rate, floating rate
unsecured, secured

186
Q

syndicated

A

an intermediate
larger bond offering
involved group of finc institutions to issue on behalf
corp debt

187
Q

tenders

A

gov=tenderts
issue directly
smaller more customisable

188
Q

call provision

A

issuer can opt to repurchase all or part of debt at or after specific date
valuable to issuer
can choose to call a bond when IR drops to save money by paying off bond and issuing another at lower IR

189
Q

put provision

A

debt holders can resell bond back to issuer at par or face value after specified period but before bonds maturity

190
Q

convertibility provision

A

debt convert to equity at given ratio

191
Q

revolving line of credit

A

max amount bank willing to lend, if guaranteed referred to as revolving

192
Q

syndicated bank loan

A

larger bank arranged loan with firm and sells portions to a syndicate pf other banks to help diversifty credit

193
Q

angel investor

A

individual investor who buys eq in small, priv firms (fam friendd)

194
Q

venture capital firm

A

intermediaries set up as limited partnerships
play active role but don’t want investment forever

195
Q

institutional investors

A

pension funds, insurance
invest directly or indirectly by becoming limited partners in a venture capital firm

196
Q

corporate investors

A

established corporations purchase equity in younger, priv companies
desire for investment returns

197
Q

IPO vs SEO

A

IPO is initial, SEO is randomly

198
Q

IPO

A

the initial offering of shares and usually where most eq is raised

199
Q

underwriter

A

a financial expert, sells, prices and has networks
transfers risk of under subscriptions and involves an outside party
issuer sells issue to uw syndicate and they resell issues to public

200
Q

types of underwriter

A

firm commitment for best effort

201
Q

risk with uw

A

that under subscribe

202
Q

dutch auction uw

A

accepts series of bids that inc price of shares and number of shares and add number of shares up until reach required to find price

203
Q

underpricing

A

tend to under price to make sure all subscribes
price IPO at value less than real value
means issuer leaves money on table

204
Q

costs of a public issue

A

5-10% usually

205
Q

SEO

A

new share issuances by a public firm after IPO

206
Q

3 diff SEO

A

rights issue, public issue and prov placement

207
Q

rights issue

A

issue of ordinary shares to existing shareholders but allowing them to maintain current state
allows shareholders to avoid dilution effect

208
Q

subscription price

A

price paid to obtain new shares issued under rights issue

209
Q

ex rights date

A

first date when new buyers will not receive right to stock

210
Q

priv placement

A

issue of large parcel of shares to institutional investors or clients of stockholders
issues at discount to encourage purchase
low cost and quick
existing shareholders don’t like as diluted their ownership

211
Q

issuing long term debt 3 ways

A

public offer (like IPO)
family issue (like rights issue)
private issue (like priv placement(

212
Q

do firms always raise funds in hope for projects

A

no

213
Q

2 implications of financing choice

A

asymmetric information
signalling effect

214
Q

Leasing definition

A

lessor remains legal owner, lessee obtains rights to use in exchange for money

215
Q

Lease

A

contractual agreement between lessee and lessor

216
Q

operating lease vs finc/capital lease

A

operating is a rental agreeement and can’t buy at end
finc is fully amortized and ownership may transfer

217
Q

operating lease

A

not fully amortised (term<useful life)
permits the use of an asset and transfers ownership after the lease period is complete
requires lessor to maintain and uphold asset
cancellation opt for lessee
flexibility for lessee
not in balance sheet
can’t buy at end

218
Q

financial lease

A

fully amortised (payments fully reco0ver cost of asset)
no maintenance or service from lessor
lessor lots of flexibility
appears on BS

219
Q

Sale and lease back agreement

A

type of finc lease
company sells to another company then leases back
lessee receives CF then pays
frees up finc resources and means don’t have any risk associated with holding

220
Q

leveraged lease

A

form of finc lease
borrows money in order to buy leased asset
3 sided agreement (lender, lessor, lessee)
lessee payments pay lessors int payments
lenders use a nonrecourse loan ( lessor not obligated to lender if lessee defaults)

221
Q

conditions to meet if a capital/financial lease

A

PV payments of lease are greater than 90% of market value of asset at start
lease transfers owners by end of term
term is greater than 75% of useful life
bargain purchase option available

222
Q

5 reasons to lease

A

flexibile financing
annual payments not lump
payments tax deductible
no risk attached to ownership of asset
deferral/smoothing of upfront purchase cost

223
Q

main difference between buying and leasing

A

tax treatment of assets and expenses is different

224
Q

CFs for buying

A

manufacturer sells asset to firm U
firm U uses and owns
firm U finances using d/e

225
Q

CFs for leasing

A

manufacturer sells asset to firm U
firm U owns but doesn’t use
firm U lessens to firm L who uses and pays lessoor
firm U finances using d/e

226
Q

main reason to borrow and then purchase

A

interest/depreciation tax shield

227
Q

why are there no Cfs with interest tax shields for NAL?

A

inc in discount rate

228
Q

NAL formula

A

L-B
think about in perspective (if you leased the cost of buying is + as you don’t have to pay)
NPV of CFs

229
Q

NAL>0

A

lease

230
Q

NAL<0

A

purchase

231
Q

NAB

A

just opposite
B-L
NAB>0 buy
NAB<0 lease

232
Q

straight down calculation of NAL 5 parts

A

cost, after tax leasing cost (Lease (1-Tc)), depreciation tax shield (Cost/LifeTc), after tax maintenance (Maintenance(1-Tc)), After tax salvage value (Sv(1-Tc))

233
Q

other way of calculating NAL

A

OC= PV lease payments and residual value- purchase price asset
NAL= (tax savings from lease- tax savings from buy)-OC

234
Q

3 steps for lessor payment calculations

A

1) amount to be amortized= PV AT lease income
= AT lease income * PVIFA
2) after tax lease income
3) lease payment= AT lease income / 1-lessor Tc

235
Q

lessor amortized amount

A

initial- PV AT Sv- PV Deep tax shield

236
Q

after tax lease income

A

amount to be amortized= PV after tax lease income

237
Q

lease payment

A

AT lease income/ 1-lessor marginal tax rate

238
Q

debt displacement

A

reducing debt with alternative forms of financing
secures funds through leasing,
goal of debt displacement is to manage a company’s debt load, often by finding more cost-effective or flexible sources of capital
lease payments create future financial obligations that are similar to debt so increase liabilities so increases D/E eq so makes levers look higher so riskier
leased assets cannot be collateral
if lease not use as much debt as if borrowed to buy
if identical firms banks should be prepared to lend more to purchasing firms as they are using more debt capacity s can cover from int side of things

239
Q

what condition must be met to carry more debt under purchase option?

A

AT CFs from buying > At Cos from leasing

240
Q

PV of differential CFs is

A

the purchasing firms additional debt capacity

241
Q

banks should be prepared to loan more to

A

purchasing firms as they are using more of their debt capacity so they can cover more payments from int side of things

242
Q

NAL in terms on debt capacity

A

NAL= purchase price- reduction in debt capacity if leasing

243
Q

smallest lease payment accept

A

make Lmin *(1-Tr) at end payment and equate to 0then solves

244
Q

after tax lease income is also the BE

A

BE NPv for income for leasing

245
Q

highest least payment pay

A

make Lmax*(1-Tc) at end then solve for 0

246
Q

tax arbitrage

A

cannot have lease if payment max pay < min payment accept

247
Q

term loan

A

borrowers with a lump sum upfront in exchange for specific borrowing terms

248
Q

amortised loan

A

annual p are same

249
Q

balloon loan

A

low during, big at end

250
Q

bullet loan

A

principal paid in full at end

251
Q

with loans to finance equipment the equipment can be used as

A

collateral

252
Q

2 types of equipment loans

A

conditional sales contract
chattel mortgage

253
Q

3 loan formulas for PV, Int and principal

A

PV loan= Annual x PVIFA
Int payment= each year BB x IR
Principal= annual p-int p

254
Q

why do you want a lower WACC

A

means less risk associated

FINC206 (4 decks)

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