206 Flashcards
1
Q
Corp finance 3 key words
A
what to invest in
how to fund it
how to manage it
2
Q
investing is all about
A
budgeting what to invest it
3
Q
how to fund it is about
A
raising cap with d/e
4
Q
how to manage it is about
A
managing CA/CL
5
Q
agency issues is when
A
principles (stockholders) and agents (managers) interests not aligned
6
Q
what causes agency issues
A
sep of control and ownership
7
Q
agency costs are
A
losses to shareholders wealth
8
Q
mitigate agency issues by
A
external audits, pay reviews
9
Q
TVM is not
A
linear
10
Q
CAGR
A
compound annual growth rate
11
Q
What is CAGR?
A
investments annual growth rate over a given period
12
Q
For NPV what is the minimum price sell
A
NPV not including initial cost
13
Q
for NPV, a higher r means
A
lower NPV and higher risk
14
Q
What does a flat term structure mean?
A
r constant
15
Q
advantages of NPV (2)
A
- includes TVM
- looks at all cash flows
16
Q
IRR assumes
A
all future CFs are reinvested at IRR
17
Q
how to work out the inflection point of 2 projects
A
A-B for each CF (or B-A)
18
Q
IRR advantages
A
easy
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
20
Q
IRR rules for investing
A
if -CFS front loaded invest if IRR>r
if -CFS back loaded invest if IRR<r
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
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
23
Q
A higher IRR means
A
more return, more efficient
24
Q
What’s scaling?
A
scaling up the more efficient project
25
Modified IRR 3)
Discounting
Reinvestment
Combination
26
Discounting MIRR
discount -Cfs back to 0 and = to Initial cost
27
Reinvestment MIRR
put all cfs (not CF0) to end of project
28
Combination MIRR
discount -Cfs back to 0 and = to ICost and pt all cfs not CF0 forward to end
29
Independent projects
Choose any
30
Mutually exclusive
rank/choose 1
31
When does NPV and IRR not give the same decision?
non-conventional CF
mutually exclusive where IC and timing of CFs are VERY different
32
Payback period advantages
easy
favors liquidity
33
disadvantages of the payback period
subjective
bias towards higher CFs early on
ignores some CFs and TVM
NPV could be -
34
Profitability index
ratio between generation of Cfs vs generation of cost
35
Advantages of PIndex
when initial investment is limited
easy
correct if independent
accounts TVM
36
Disadv of PIndex
problems with mutually exclusive
ignores higher NPV
37
Capital budgeting decision is the
investment in NCA
38
3 key parameters of FCFs
size, timing, risk
39
finance vs accounting cfs
Finance
- valuing a CFs
- what is it, timing, risk
-where are we going?
Act
- what happened, where are we now?
- place to start
40
Revenues, Costs and Depreciation contribute (+/-) to CFs
+-+
41
$1 increase in x (inc/decr) CF
inc r, inc cf
inc c, decr cf
incr dep, incr cf
42
Depreciation is not
a real CF
43
Depreciation is a ___ because
tax shelter because it reduces taxable income
44
EBT
Earning before tax
R-FC-FC-Dep
45
Tax
EBT x TR
46
EAT
EBT- Tax
47
OCF
EAT + dip
48
NWC
cash to run day-to-day
not consumed but employed
49
increase in WC is an
outflow because it is tied up and cannot be used anywhere else and does not make any returns
50
NWC is in
inventory on books
51
Income tax is a
cash outflow
52
Book value
is how much you can sell for from IRR
53
a positive externality is a
synergy and increases CF of the project
54
a negative externality is a
erosion and decreases CF of the project
55
change in NWC
NWC yesterday - NWX today
56
nominal
actually generated without impact of inflation
57
real
Cfs with adjustment for inflation
58
inflation
increasing prices in economy, when basket of goods (CPI) increases
59
What's wrong with mutually exclusive projects with different lives?
NPV may not be accurate as to where the big CFs fall
60
Ways to even out project lives
Lowest common multiple life
NPV perpetuity
Equivalent Annual Annuity
61
LCM life
extend/replicate out to lowest common life
62
NPV perpetuity assumes
assumes both chains of replacement continues forever
63
EAA, EAC, EAV
Equivalent annual annuity, equivalent annual costs, equivalent annual value
64
PVIFA
PV interest factor annuity just short version of the annuits of CFS
65
Do you want higher/lower EAV, or EAC?
high EAV, low EAC
66
LCM, Perp, EAA rules have identical returns and diff
identical, all 3 give the same
diff, NPV perp is best
NPV perp and LCM give diff and EAA not appropriate
67
2 types of uncertainty
Direct
- binary
- diffuse
Indirect
68
Direct uncertainty-binary, diffuse
binary is competition investment
diffuse, consumer demand or cost of inflation
69
indirect
financial markets/access to cap
70
Sensitivity analysis
effect on NPV while changing one variable and holding the others constant
71
Sensitivity analysis
effect on NPV while changing one variable and holding the others constant
72
a changing variable for sensitivity analysis could be
market size
73
Scenario analysis
effect on NPV of a particular combination of assumptions
74
Accounting break even
sales which net profit=0
75
Finc break even
sales when NPV=0
76
Accounting vs finc break-even point for NPV
accounting NPV=(-)
finance NPV=0
77
finc break-even IRR
= r required
78
marginal cost
cost to produce 1 more unit
79
marginal cost is the same as
variable cost
80
what does the monte carlo simulation do?
models real-world uncertainty
81
steps of monte carlo simulation
-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
82
financial option
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
83
Real options
opportunities to vary the nature or longevity of the project
expand, abandon, delay
84
real options analysis disadvantages
complicated and complex to communicate with managers/shareholders
lots of theories/assumptions
could increase agency problems
85
decision trees are good because
they are graphical, so easy to understand
86
Total value of assets is
current assets + fixed assets (tang and intangible)
87
Total value of firm to investors
current liabilities, long-term debt, shareholders equity
88
Capital structure is made up of?
debt, equity
89
Goal of capital structure mix is to find the mixture that
minimizes WACC, maximizes firm value
90
A=
E+L
91
Value of a firm
D+E
92
Accounting vs finc approach for valuing a firm
acct:
on a ledge D+E=Value
finc:
V=PV of all CFs
93
Business risk
possibility profits could be lower
equity risk arising from firms operating activities
94
business risk does not inc
financing effect
95
business risk is influenced by
numerous factors (competition, demand, govt policy)
96
financial risk
equity risk from financial policy (cap structure)
97
financial risk means and a
additional risk on shareholders as a result of financial leverage
98
financial risk depends only on
type of securities issued
99
financial leverage
use of debt
100
Advantages of leverage
- higher return on equity
-higher variability in return equity
-increases opportunities
101
Net income
EBIT-Interest
102
EPS
NI/Shares number
103
ROE
NI/E
104
ROAss
EBIT/Assets
105
equity is the
claim on future earnings of a company
106
equity is the
claim on future earnings of a company
107
With debt if earnings are good...
we perform better than without
108
if EBIT
lev not helpful
109
what must happen for leverage to increase ROEq? why?
ROA>Rb
the company needs to earn more from its assets (ROA) than it pays in interest on its deb
110
homemade leverage is the
use of personal borrowing/lending to alter leverage
111
homemade leverage means s..
shareholders can adjust the amount of financial leverage by borrowing/lending on their own
112
2 portfolios can have
un lev firm, lev ourselves
lev firm, risk free rate
113
capital structure assumptions
perfect markets
homogenous expectations, business risk classes
perpetual CFs
114
MM proposition 1 is all about
valuation
115
MM Prop 1
cap structure is independent in determining value of firm
116
MM Prop 1 equation
Vu=Vl
117
MM1 Prop is saying
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
MM1 Prop means firm A
can just borrow to match the cap structure of firm B
119
MM1 Law of one price
investor pays the same price for identical CFs
120
MM1 means for WACC
that it is constant across all levels of lev
121
MM Prop 2 is all about
cost of capital
122
MM2 is that
required Re arises from sources of firm risk
123
debt increases what type of risk? u/s?
systematic which is market risk
124
What happens to ROEq when lev increases?
increases as shareholders need more compensation
125
why are interest payments lit comp to divs?
they are tax deductible where as divs are not
126
more interest means,
less taxable income
127
with taxes taken into account what is the value of a levered firm
Vl=Vu+tB
128
in a no tax world and markets are efficient what does this mean for us?
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
in the tax world due to the tax shield what happens to cost of debt
cost of debt decreases, WACC decreases and hence, firm value increases
130
WACC is the
cost of capital and it reflects how the firm is funded
131
Critique for MM
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
Bankruptcy is when __ much of the firm is in debt
nearly 100%
133
Direct and indirect costs of bankruptcy
direct: lawyer's fees
indirect: loss of opportunities from business
134
costs associated with bankruptcy affect firm value how?
lower
135
agency costs of debt
conflict that arises between shareholders and debtholders
136
3 selfish strategies of a stockholder within agency costs of debt
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
2 ways to decrease costs of financial distress
protective convenants
debt consolidation
138
Protective convenants
+
keep biz running at min level
-
agreement for d/e holders to limit actions a firm can take (mergers)
139
debt consolidation
taking out a loan to pay off debt
140
static trade-off theory of capital structure
there is a trade-off between the tax advantage of debt and the costs of financial distress, only to a pt
141
is there an optimal pt where cap structure max value, min WACC?
yes
142
in a static world this an optimal __
B*
143
optimal capital structure is __ and firm is __
static but dynamic
144
taxes and bankruptcy costs are just
other claims on CFs of a firm, more pieces of pie
145
Agency costs of d/e ratio
work harder with debt, less FCF (paid out as divs) for managers to waste
146
Tax benefit and decreased agency costs of eq advantage of debt
- int payments are tax deducible meaning less taxable income
- Increased divs means less FCF for managers to waste
147
bankruptcy costs and agency costs of debt disadvantage of debt
- if firm cannot meet obligations then more financial distress
- managers hurt bondholders and boost eq holders (selfish strategies)
148
personal taxes mean eq income faces but int payments are
2x taxation (firms and shareholders)
only taxed individually
149
MM and personal taxes mean that corporate tax benefits of
lev are partially offset by personal taxes
150
2 special cases of personal tax
MM w/corp taxes Tps=Tpb so the gain from lev=Tcb
MM w/out corp taxes, gain lev=0
151
classical tax system favors
corporate tax
152
imputation tax system means
tc=0
153
in terms of div payments imputation tax system means
you get tax credited with div payments as corp taxes already paid on income
154
dividend imputation means what for debt?
debt becomes less attractivwe
155
agency costs and information asymmetries and at announcement
if Veq
156
pecking order theory
retained earnings (internal)
debt
equity
157
if internal CFs> capital investment
use surplus to pay debt
158
debt ratio in pecking order theory
reflects the requirement for external financing
159
pecking order theory is at odds with
trade-off theory
160
EBIT does what when D increases
decreases
161
3 ways to value a project with leverage
1) adjusted present value
2) flow to equity
3) wacc method
162
APV incorporates
financing aspects
163
3 main side effects of financing APV
tax subsidy of debt
costs of issuing new securities
subsidy to debt financing
164
tax subsidy to debt APV means timeline-wise
borrow (+CF) year 0
pay int (-CF) years
165
costs of issuing new securities APV means timeline-wise
pay floatation cost (-CF) year 0
receive tax shield (+CF) years
166
costs of subsidy to debt financing APV means timeline-wise
borrow (+CF) year 0
pay int (-CF) years
167
flow to equity is where you discount
CF from projects to eq holders of lev firm at cost of levered equity capital
Discount LCFs at Rs
168
WACC method
discount UCF at WACC
169
pure play firm ___ can be used for__
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
difference between long-term financing
ownership vs debt
171
financing order
equity
debt
ret earnings
172
financial deficit
difference between use of cash flow and internal financing
173
debt financing summary
not owners
no voting rights
int payments tax deductible
legal abilities
Excess debt= financial distress
int payments inc in cost of doing business
174
equity financing summary
ownership
voting rights
divs not tax deductible
divs not part of doing business costs
no legal claims
cannot go bankrupt
175
indenture
contract
176
collateral
financial securities or any asset pledged to the debt
177
mortgage
secured by real property
178
seniority
debt holders paid first
179
covenants
restrictive clauses in a bond contract to limit issuer taking actions that could hurt bondholders
180
bond covenant examples
issuing new debt, div/share repurchases, m and acq, asset disposition
181
debenture
unsecured bond
182
note
unsecured bond t<10
183
registered
keeps initial record of who purchased bond and change of owners
184
bearer bond
holder of bond=owner
185
3 forms of debt financing
0 coupon, non-0 coupon
fixed rate, floating rate
unsecured, secured
186
syndicated
an intermediate
larger bond offering
involved group of finc institutions to issue on behalf
corp debt
187
tenders
gov=tenderts
issue directly
smaller more customisable
188
call provision
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
put provision
debt holders can resell bond back to issuer at par or face value after specified period but before bonds maturity
190
convertibility provision
debt convert to equity at given ratio
191
revolving line of credit
max amount bank willing to lend, if guaranteed referred to as revolving
192
syndicated bank loan
larger bank arranged loan with firm and sells portions to a syndicate pf other banks to help diversifty credit
193
angel investor
individual investor who buys eq in small, priv firms (fam friendd)
194
venture capital firm
intermediaries set up as limited partnerships
play active role but don't want investment forever
195
institutional investors
pension funds, insurance
invest directly or indirectly by becoming limited partners in a venture capital firm
196
corporate investors
established corporations purchase equity in younger, priv companies
desire for investment returns
197
IPO vs SEO
IPO is initial, SEO is randomly
198
IPO
the initial offering of shares and usually where most eq is raised
199
underwriter
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
types of underwriter
firm commitment for best effort
201
risk with uw
that under subscribe
202
dutch auction uw
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
underpricing
tend to under price to make sure all subscribes
price IPO at value less than real value
means issuer leaves money on table
204
costs of a public issue
5-10% usually
205
SEO
new share issuances by a public firm after IPO
206
3 diff SEO
rights issue, public issue and prov placement
207
rights issue
issue of ordinary shares to existing shareholders but allowing them to maintain current state
allows shareholders to avoid dilution effect
208
subscription price
price paid to obtain new shares issued under rights issue
209
ex rights date
first date when new buyers will not receive right to stock
210
priv placement
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
issuing long term debt 3 ways
public offer (like IPO)
family issue (like rights issue)
private issue (like priv placement(
212
do firms always raise funds in hope for projects
no
213
2 implications of financing choice
asymmetric information
signalling effect
214
Leasing definition
lessor remains legal owner, lessee obtains rights to use in exchange for money
215
Lease
contractual agreement between lessee and lessor
216
operating lease vs finc/capital lease
operating is a rental agreeement and can't buy at end
finc is fully amortized and ownership may transfer
217
operating lease
not fully amortised (term
218
financial lease
fully amortised (payments fully reco0ver cost of asset)
no maintenance or service from lessor
lessor lots of flexibility
appears on BS
219
Sale and lease back agreement
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
leveraged lease
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
conditions to meet if a capital/financial lease
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
5 reasons to lease
flexibile financing
annual payments not lump
payments tax deductible
no risk attached to ownership of asset
deferral/smoothing of upfront purchase cost
223
main difference between buying and leasing
tax treatment of assets and expenses is different
224
CFs for buying
manufacturer sells asset to firm U
firm U uses and owns
firm U finances using d/e
225
CFs for leasing
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
main reason to borrow and then purchase
interest/depreciation tax shield
227
why are there no Cfs with interest tax shields for NAL?
inc in discount rate
228
NAL formula
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
NAL>0
lease
230
NAL<0
purchase
231
NAB
just opposite
B-L
NAB>0 buy
NAB<0 lease
232
straight down calculation of NAL 5 parts
cost, after tax leasing cost (Lease *(1-Tc)), depreciation tax shield (Cost/Life*Tc), after tax maintenance (Maintenance*(1-Tc)), After tax salvage value (Sv*(1-Tc))
233
other way of calculating NAL
OC= PV lease payments and residual value- purchase price asset
NAL= (tax savings from lease- tax savings from buy)-OC
234
3 steps for lessor payment calculations
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
lessor amortized amount
initial- PV AT Sv- PV Deep tax shield
236
after tax lease income
amount to be amortized= PV after tax lease income
237
lease payment
AT lease income/ 1-lessor marginal tax rate
238
debt displacement
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
what condition must be met to carry more debt under purchase option?
AT CFs from buying > At Cos from leasing
240
PV of differential CFs is
the purchasing firms additional debt capacity
241
banks should be prepared to loan more to
purchasing firms as they are using more of their debt capacity so they can cover more payments from int side of things
242
NAL in terms on debt capacity
NAL= purchase price- reduction in debt capacity if leasing
243
smallest lease payment accept
make Lmin *(1-Tr) at end payment and equate to 0then solves
244
after tax lease income is also the BE
BE NPv for income for leasing
245
highest least payment pay
make Lmax*(1-Tc) at end then solve for 0
246
tax arbitrage
cannot have lease if payment max pay < min payment accept
247
term loan
borrowers with a lump sum upfront in exchange for specific borrowing terms
248
amortised loan
annual p are same
249
balloon loan
low during, big at end
250
bullet loan
principal paid in full at end
251
with loans to finance equipment the equipment can be used as
collateral
252
2 types of equipment loans
conditional sales contract
chattel mortgage
253
3 loan formulas for PV, Int and principal
PV loan= Annual x PVIFA
Int payment= each year BB x IR
Principal= annual p-int p
254
why do you want a lower WACC
means less risk associated
-
Key Links
-
Subjects
-
Company
-
Find Us
-
