Chapters 11 -12 Flashcards
when is debt particularly low risk
when its secured on a specific asset
when its secured on a general asset
it is due to be repaid in the short term
what kind of charge is it, when a loan is secured on a specific asset
fixed
what kind of charge is it when a loan is secured on general assets
floating
order of the creditor hierarchy
creditors with fixed charge creditors with floating charge unsecured creditors preference shareholders ordinary shareholders
expression for return expected by debt holders
Kd or rd
expression for return expected by
Ke or re
expression for cost of preference shares
Kpref or Kp
what does D1 mean
dividend in 1 years time
what does D0 ( 1 + G) mean
D0 is latest dividend paid
g is annual dividend growth rate
what is P0
expected dividend yield
what is a cum div
the current share price if a dividend is about to be paid
formula for calculating growth rate
1 + g = (latest dividend / earliest dividend) to the power of 1/n
where n is number of growth periods
in the formula g = bre, what is b
balance of profits reinvested at a percent
what does CAPM stand for
capital asset pricing model
what is unsystematic risk
component of risk that is associated with investing in a particular company
what is systematic risk
component of a risk that will remain even if a diversified portfolio has been created
what are beta factors
measures the average change in the return on a share each time there is a change in the stock market as a whole
what does a beta factor of below 1 mean
below average risk,
what does a beta factor of 1 mean
average risk, moves in line with market
what does a beta factor of above 1 mean
above average risk
what is market or equity risk premium
difference in expected average market return and risk free rate of return
what does Rf mean
risk free rate
what does Rm mean
market return
what does E(Ri) mean
expected return
what does (E(rm)-Rf) mean
market risk premium
drawbacks of CAPM
only a single period model
beta values are historic and therefore not accurate
CAPM ignores size of company
formula for cost of irredeemable loan notes
Kd ( pre-tax) = I / Po
where I is interest paid and Po is market value of debt
formula for impact of corp tax on irredeemable loan notes
Kd ( post tax ) - I (1-T)/ Po
IRR Formula for redeemable debt
a% + (NPVa/ NPVa-NPVb) x (b%-a%)
what is WACC
weighted average cost of capital
what is Ve in WACC formula
total market value of shares ( ex div)
what is Vd in WACC formula
total market value ex interest of debt
what is Kd in WACC formula
cost of debt
what is Ke in WACC formula
cost of equity in a geared company
if there is a choice, should you use book or market values when calculating WACC
market
what is capital structure
the capital structure of a company refers to the mixture of debt and equity finance used by a company
disadvantage of debt finance compared to equity
debt increases dividend variability
worsens interest and gearing ratios
debt payments must be made even if a business doesnt make a profit
adv’s of debt compared to equity
cheaper
better impact on EPS
quicker than issuing shares
interest repayments attract tax relief
what does the traditional theory state
debt brings benefits, up to a certain level of gearing
drawbacks of the traditional theory
it doesnt identify optimal levels of gearing
fails to consider impact of tax
what is arbitrage
purchase and sale of a security takes place simultaneously in different markets, with the aim of making a risk free profit through the exploitation of any price difference between markets
what order is the pecking theory order
use internal funds if available
use debt
convertible debt
preference shares
issue new equity
what is an asset beta
an ungeared beta, ie only measures business risk
what is equity beta
a measure of the systematic risk of a share, including its business and financial risk
what is the funding gap
inability of SME’s to raise adequate finance
why is it that SMEs find it hard to raise adequate finance
business is owned by a small group of investors amd is likely to be unquoted
greater failure rate of SMEs
knowledge of sources of finances may be limited
what is the maturity gap
when medium sized business cannot obtain more debt finance as they have inadequate security
what is business angel financing
when a wealthy individual or groups of individuals invest directly into an SME
What is supply chain finance
where a middle man company pay off debts with a discount to the receiver so they are able to get the cash asap, and the sender of the funds can wait the full payment terms to pay the middle man
