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CIMA - F3 > 4. Overview of Finance Sources and Equity Finance > Flashcards

4. Overview of Finance Sources and Equity Finance Flashcards

1
Q

What should the market value of a share represent?

A

The present value of the expected future cashflows for the shareholders (discounted at cost of equity)

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2
Q

What should the market value of a bond represent?

A

The present value of the expected future cashflows for the bondholder (discounted at cost of debt)

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3
Q

What are 4 short term sources of debt finance?

A
  1. Overdrafts
  2. Short term bank loans
  3. Commercial papers
  4. Eurocurrency loans
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4
Q

What is a commercial paper?

A

Short term debt issued by large companies at a discount and redeeming at par

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5
Q

What are 5 medium term sources of debt finance?

A
  1. Bank loans
  2. Medium term notes
  3. Floating rate notes
  4. Mezzanine finance
  5. Leasing/ sale and lease back
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6
Q

What are medium term notes?

A

Issued by companies and paying a set coupon until redeeming at a fixed maturity date for a set amount

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7
Q

What is mezzanine finance?

A

High coupon debt that is subordinated (has lower ranking that other debt)

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8
Q

What are 4 long term sources of debt finance?

A
  1. Bonds/ loan stock
  2. Convertible bonds
  3. Bonds with warrants
  4. Eurobonds
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9
Q

What are 6 sources of equity finance/cash?

A
  1. Ordinary shares
  2. Preference shares
  3. Retained cash
  4. Venture capital
  5. Business angels
  6. Government assistance
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10
Q

What are the money markets?

A

Short term interest rate markets for investing and borrowing used for managing working capital

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11
Q

What are capital markets?

A

Long term debt and equity markets used for managing capital structure

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12
Q

What are the 4 functions of a stock market?

A
  1. Enabling companies to raise new finance (primary)
  2. Enable existing investors to sell
  3. Aid takeovers
  4. Enable private company shareholders to realise their investment
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13
Q

What are the 4 functions of a corporate bond market?

A
  1. Enable companies to dis-intermediate
  2. Enable companies to raise new debt finance
  3. Enable existing debt investors to sell their debt
  4. Aid takeovers by issuing debt to finance the takeover
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14
Q

What are the 3 benefits of listing shares on a recognised stock exchange market?

A
  1. Making shares more desirable
  2. Easier to issue new shares to investors
  3. Provide a means to value
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15
Q

What are the 4 main economic factors that cause a change in share price?

A
  1. Interest rates
  2. Exchange rates
  3. Legislation
  4. Inflation
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16
Q

What are the 3 main industry factors that cause a change in share price?

A
  1. Actions of competitors
  2. Regulator actions
  3. Changes in technology
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17
Q

What are the 4 main company factors that cause a change in share price?

A
  1. Announcements
  2. Management changes
  3. Projects undertaken
  4. Financing used
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18
Q

What is a rights issue of shares?

A

An invitation to existing shareholders to purchase additional shares in proportion to their current holding

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19
Q

What is a public offer of shares?

A

Shares offered to the public usually at a fixed price, often underwritten

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20
Q

What is a private placing of shares?

A

Issuing to a select group of investors (less costly)

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21
Q

What is a tender offer?

A

Where investors make an offer for shares at or above a minimum fixed price

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22
Q

How is a strike price set on tender offers?

A

Starting with the highest bid and descending until the desired number of shares is met, the strike price is the lowest price reached and all are charged that strike

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23
Q

What do private equity firms do?

A

Identify promising companies to invest in with a view to generate healthy long run returns

24
Q

What happens to shareholders existing percentage holding of shareholders if they take up their rights in a rights issue?

A

It remains the same

25
Q

Why is a rights issue done at a discount?

A

To ensure that the rights issue is fully subscribed

26
Q

What are shareholders 3 options under a rights issue?

A
  1. Do nothing (value shareholding falls)
  2. Sell their rights (get cash but holding falls)
  3. Subscribe for the shares
27
Q

What is the theoretical ex rights price calculation?

A

1 / (N+1) * ((N x cum rights price) + issue price)

28
Q

What is the alternative equation for theoretical ex rights price?

A

(Market cap prior to issue + rights proceed) / Total number of shares after

29
Q

If the NPV of the project funded by a rights issue is known, what is the theoretical ex rights price calculation?

A

(Market cap prior to issue + rights proceed + project NPV) / Total number of shares after

30
Q

What is the equation for the value of one right?

A

TERP - the issue price

31
Q

What is the yield adjusted theoretical ex rights price calculation?

A

1 / (N+1) * ((N x cum rights price) + issue price*(new yield/old yield))

Where old yield is the current WACC

32
Q

How does an investors wealth change if they take no action on a rights offering?

A

Wealth reduces by the difference in cum div price and TERP, multiplied by the number of shares owned

33
Q

How does an investors wealth change if they sell their rights under a rights issue?

A

Wealth increases by the value of the right multiplied by the number of rights sold, and reduces by the difference in cum div price and TERP, multiplied by the number of shares owned

34
Q

How does an investors wealth change if they take up their rights under a rights issue?

A

Wealth reduces by the offer price multiplied by the number of shares to be taken up, and increases by the change in value of their shareholding

35
Q

What is a company’s cost of capital?

A

The minimum return required when using the company’s funds

36
Q

What is a company’s cost of equity?

A

The minimum return that shareholders require from the funds they have invested in the company

37
Q

How does the dividend valuation model calculate a share price?

A

As the present value of a stream of constantly growing dividends (growing perpetuity discounted at the cost of equity)

38
Q

What is the DVM model equation for an ordinary share price?

A

Current ex div share price = (Current dividend x (1+g)) / (cost of equity - g)

39
Q

If there is zero growth in dividends or profits (i.e. all earnings are paid out as dividends), what is the equation for cost of equity?

A

PAT / Market Capitalisation OR EPS / Share Price

40
Q

What is the gordon growth model estimate for growth rate?

A

r x b

r = ROCE
b = proportion of funds reinvested in the business

41
Q

What is the historic growth model estimate for growth rate?

A

g = nth root (current div / historic div)

where n = number of years passed

42
Q

What does risk represent?

A

The likelihood and impact of returns being either higher or lower than expected

43
Q

What is business risk?

A

Variability of profits before interest and tax

44
Q

What are the 2 elements of business risk?

A

Specific and systematic

45
Q

What is specific business risk?

A

Variability in PBIT due to specific company factors e.g. equipment failure, product faults/approvals

46
Q

How can investors manage specific business risks?

A

Diversify their investments

47
Q

What is systematic business risk?

A

Variability in PBIT due to macro economic factors e.g. the economy, FX, interest rate moves - impacted by business sector and level of operational gearing

48
Q

What does β measure?

A

A company’s exposure to systematic business risk

49
Q

What does portfolio theory state?

A

That it is possible to diversify away exposure to specific risk by holding shares in a diverse selection of different companies

50
Q

Can you diversify away systematic business risk?

A

No

51
Q

What does the CAPM model do?

A

Directly links risk with investors required return

52
Q

What is the formula for cost of ordinary (equity) share capital, using the CAPM?

A

k = Rf + (Rm - Rf)*β

Rf = risk free rate
Rm = average return on the market as a whole

53
Q

What is the equation for the market risk premium?

A

Rm - Rf

54
Q

What does a β factor of 1 mean?

A

The volatility of returns matches the overall market and you would expect a return equal to that which you would get from the overall market, Rm

55
Q

What is the cost of irredeemable preference shares, or shares with no growth in dividend?

A

kpref = d / P

CIMA - F3 (13 decks)

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