Corp Fin Flashcards
1
Q
Motives for merger
A
Create synergy Growth Increase mkt power Acquire unique capabilities Diversify (conglomerates) Bootstrap earnings (???) Manager personal incentives Tax savings Unlock hidden value Cross border motivation
2
Q
Forms of integration
A
Statutory merger
Subsidiary merger
Consolidation
3
Q
Industry lifecycle stages
A
- Pioneering development
- Rapid accelerating growth
- Mature growth
- Stabilization & mkt maturity
- Deceleration of growth & decline
4
Q
Pioneering Development
A
Horizontal merger, Conglomerate
(Low but increasing sales growth, large development costs)
- Acquirer POV: Startups sell to large firms as new source of growth
- Target POV: pool/access to mgmt and capital resources
5
Q
Rapid accelerating growth
A
Horizontal merger, Conglomerate
(High profit margins, low competition)
• Meet capital requirements for expansion
6
Q
Mature growth
A
Horizontal, vertical
(Decrease in new entry, growth potential remains)
• for economies of scale, savings & operational efficiencies
7
Q
Stabilization and mkt maturity
A
Horizontal
(Increasing capacity constraints, increasing competition)
- for economies of scale to match low pricing
- lg companies buy small companies to improve mgmt & financial base
8
Q
Deceleration of growth and decline
A
Horizontal, vertical, conglomerate
(Overcapacity, eroding profit margins)
- horizontal mergers to ensure survival
- vertical mergers to increase efficiency & profit margins
- conglomerate mergers to exploit synergy
- may acquire growth from younger industries
9
Q
Factors affecting choice of pmt
A
- if ACQUIRER believes merger to create value, push for cash offering
- if TARGET believes merger to create value, push for stock offering
10
Q
Pre-Takeover defense
A
- Poison pills/puts
- Incorporate in state with restrictive takeover laws
- Staggered BoD
- Restricted voting rights
- Supermajority voting provision
- Fair price amendments
- Golden parachutes
11
Q
Poison pills
A
(Pre-Takeover defense)
Grants right to issue stock options to existing shareholders with severely discounted exercise prices
Flip-in: gives target right to buy target shares
Flip-over: gives target right to buy acquirer’s shares
Dead hand: poison pill to be redeemed or cancelled by a vote of continuing directors
12
Q
Poison puts
A
(Pre-Takeover defense)
Gives target BONDholders right to sell bonds back to target at above par value in event of takeover.
After takeover, acquirer needs to raise cash to refinance debt
13
Q
Restricted voting rights
A
(Pre-Takeover defense)
Precludes shareholders who recently purchased large block of shares from exercising voting rights
14
Q
Supermajority voting provision
A
(Pre-Takeover defense)
Target changes charter and bylaws to require higher % approval by shareholders for mergers (80% vs 51%)
15
Q
Fair price amendments
A
(Pre-Takeover defense)
Changes to the corporate charger which only allows mergers with offer price > threshold
16
Q
Golden parachutes
A
(Pre-Takeover defense)
Execs get lucrative payouts if they leave after chg in corporate control. Doesn’t deter, but pacify mgmt concerns abt job loss
17
Q
Post takeover defense
A
- Just say no
- Litigation
- Greenmail
- Share repurchase
- Leveraged recap
- Crown jewel defense
- Pac Man defense
- White knight/squire defense
18
Q
Litigation
A
(Post takeover defense)
Go to court for violation of antitrust or securities laws
19
Q
Greenmail
A
(Post takeover defense)
Premium payoff to acquirer to terminate takeover (repurchase shares). There’s a 50% tax on acquirer’s profits
20
Q
Share Repurchase
A
(Post takeover defense)
Raises share price
21
Q
Leveraged recap
A
(Post takeover defense)
Issues lg debt to repurchase shares
22
Q
Crown Jewel
A
(Post takeover defense)
Sells off valuable asset to make firm less attractive
23
Q
Pac Man
A
(Post takeover defense)
Target attempts hostile takeover of acquirer (rare)
24
Q
White knight
A
(Post takeover defense)
Encourages 3rd firm to acquire target (more acceptable to target mgmt)
25
White squire
(Post takeover defense)
3rd party purchase substantial minority stake (large enough to block takeover)
Risk of litigation here
26
Herfindahl Hirschman Index (HHI)
Post merger HHI:
Less than 1000, not concentrated
1000 to 1800, moderately concentrated
More than 1000, highly concentrated
Post merger HHI:
Less than 1000, (any amt, no action)
1000 to 1800, (100+ chg, possible challenge)
More than 1000, (50+ chg, challenge)
27
Basic forms of restructuring
Equity carve out
Spin-off
Split-off
Liquidation
28
Equity carve out
Company splits 1 of divisions to create new entity and offer shares to outsiders (cash inflow)
the ex-parent usu maintain some control of the business split out
29
Spin-off
Separates 1 of divisions to create new entity but shares are proportionally issued to current shareholders
30
Split-off
Separates 1 of divisions to create new entity and offers current shareholders shares in new entity in exchange for parent
31
2 objectives of corp gov
1. Eliminate conflicts of interest
| 2. Ensure company assets are used in best interest of investors & stakeholders
32
Effective corp gov system has:
1. Clear description of RIGHTS of shareholders and stakeholders
2. Defines responsibilities of managers and directors to stakeholders
3. Identifies measurable accountabilities for performance
4. Ensures fairness and equitable treatment in all dealings b/w managers, directors and shareholders
5. Ensure transparency and accuracy in disclosures of operations, performance, risk, financial position
33
BoD has responsibility to:
1. Establish corporate values and governance structures for ethical, competent, fair and professional conduct
2. Ensure all legal and regulatory requirements are met, complied with fully and timely
3. Establish LT strategic obj for company with goal of ensuring the best interests of shareholders served
4. Establish clear responsibilities and accountability system & performance measurement in all ops
5. Here CEO, determine comp package & periodically evaluate officer's performance
6. Ensure management has supplied board with sufficient info to be fully informed & prepared to make decisions
7. Meet freq enough to adequately perform duties & meet in extraordinary session as required by events
8. Acquire adequate training so members are able to adequately perform duties
34
Staggered boards are good/bad for corp gov?
Good, allows continuity of knowledge & experience
35
Stakeholder impact analysis (SIA)
1. Identify stakeholders
2. Identify stakeholders interests & concerns
3. Identify what claims stakeholders are likely to make on org
4. Identify stakeholders most important to org
5. Identify resulting strategic challenges
36
Philosophical approach to ethics
1. Friedman doctrine
2. Utilitarian ethics (majority rules)
3. Kantian ethics (ends rather than means)
4. Rights theories (fundamental rights)
5. Justice theories (equal dist)
37
Dividend irrelevance theory (dividends don't matter)
Homemade dividends
38
Bird in hand (dividend matters)
Prefer current dividends over equal amt of potential capital gains from reinvesting earnings (uncertainty)
39
Tax argument (dividend matters)
Higher tax on dividends than capital gains means preference for reinvesting earnings
40
Dividend imputation system
Dividends taxed ONCE @ shareholder's MTR (Australia, New Zealand, France)
If investor's MTR is lower than CTR, a tax credit is received
Otherwise pay additional taxes
41
Split rate tax system
Earnings distributed as div are taxes lower than earnings retained by company. Div taxed again at shareholder lvl.
42
3 dividend policies
1. Stable
2. Constant
3. Residual
43
Stable dividend policy
Companies seek to increase dividends each year at a constant rate
44
Constant dividend policy
Keep constant dividend payout ratio
Dividends will vary with earnings, more volatile and a higher risk premium attached
45
Residual dividend policy
1st use internally generated funds to finance investments in positive NPV projects consistent with target capital structure
Remaining funds distributed entirely as dividends
46
Pros of share repurchases
```
Potential tax adv
Share price support (positive signal)
Managerial flexibility
Offset earnings dilution from employee stock options
Increase financial lvg
```
Rises when company is strong and falls during recessions
47
Effects of share repurchases
If borrowed funds are used to finance repurchase:
the after tax Rd > earnings yield, EPS FALLS
the after tax Rd
48
Effects of share repurchase on BV
When mkt price > BVPS, BVPS FALLS after repurchase
When mkt price
49
Jensen's FCF hypothesis
Managers endowed with FCF will invest in negative NPV projects rather than pay to shareholders
So dividends and debt can mitigate the over investment agency issue
50
MM1 (w/o taxes) : capital structure irrelevance
| VL = VU
1. Investors have homogenous expectations of CF from bonds & stocks
2. Capital mkts are perfect (no taxes, transaction costs, bankruptcy costs) symmetric info, same stuff, same price
3. Borrow & lend at rf rate
4. No agency costs, managers act in shareholder's best interest
5. Financing & investment decisions independent of each other (op income unaffected by capital structure)
51
MM2 (w/o taxes): higher financial lvg raises Re
Re = Ro + (Ro - Rd)*(D/E)
The cost of equity is a linear function of the company's debt/equity ratio
52
MM2 (w/o taxes): equity beta
Beta(E) = Beta(A) + [Beta(A) - Beta(D)]*(D/E)
Equity beta increases as D/E ratio increases
53
MM1 (with taxes)
| VL = Vu + (D)*(t)
With taxes, and no costs of financial distress & bankruptcy, debt offers tax benefits.
Value of company increases when more debt is issued
54
MM2 with taxes
Re = Ro + (Ro - Rd)*(1-t)*(D/E)
Company value increases when more debt is issued
55
Agency Costs
1. Monitoring costs (10-k, BoD)
2. Bonding costs (explicit, implicit) non-compete contracts, insurance for performance guarantee
3. Residual loss: costs incurred despite monitoring & bonding
Higher debt limits opportunities for mgmt to misuse cash
56
Pecking Order theory (costs of asymmetric info)
Managers prefer modes of financing that offer lease info content to outsiders
Debt issuance: positive
EQ issuance: negative
Costs of asymmetric info decrease as more debt is issued
57
Static-Trade off theory (optimal capital structure)
After Acctg for costs of financial distress,
VL = VU + (t)*(D) - PV(costs of financial distress)
58
International diff in capital structure
France, Italy and Japan use more debt than US, UK
Namerica use more LT debt than Japan
Developed mkts use more LT debt than emerging countries
Countries with weaker legal systems have higher financial lvg and more use of ST debt
59
Effects of inflation on capital budgeting
Higher than expected inflation:
• increases real taxes, by reducing value of depreciation tax shelter (unless tax system adjusts dep for inflation)
• decreases real interest exp
60
Expected inflation & WACC
Increase in expected inflation will increase WACC
61
2 methods for finding NPV of mutually exclusive projects with unequal lives
1. Lease common multiple of lives approach
| 2. EEM
62
NPV vs IRR
Independent projects: NPV & IRR same results
Accept positive NPV & IRR>cost of capital
Mutually exclusive projects: NPV & IRR differ. NPV best, realistic reinvestment rate assumption @ required rate of return
IRR: assumes interim CF reinvested at IRR
63
Capital Rationing
Start with highest PI to lowest
64
Sensitivity, scenario & Monte Carlo analysis
1. Sensitivity: 1 input variable at a time
2. Scenario: multiple variables
3. Monte Carlo: simulation
Greater the dispersion of NPV, higher the risk
65
Monte Carlo analysis
Estimate probability distribution of outcomes for project NPV & IRR
Define prob dist for input variables instead of point estimates in scenario analysis
Run simulation thousands of times to get distribution for possible NPV & IRR
Inputs: assumed distribution & mean/std
Positive skewness: skewed to the right
66
Diff between Acctg and economic income
Acctg depreciation: based on original cost of investment
Economic depreciation: based on MV asset
Interest Exp: subtracted from Acctg income, not considered in economic income (implicitly in required rate of rtn)
67
3 diff valuation approaches in capital budgeting
1. Economic profit/WACC
2. Residual income/Re
3. Claims valuation/Rd, Re separate
All should lead to the same value
68
4 Risks
1) Asset risk
2) Liability risk
3) Financial disclosure (acctg risk)
4) Strategic policy risk
69
BoD best practices:
| Composition of Board
75% of board members are independent
70
BoD best practices:
| Chairman
Independent
| Chairman CEO
71
BoD best practices:
| Election
Annual re-election
72
BoD best practices:
| Meetings
requires independent board members to meet in separate sessions AT LEAST annually; qtrly is preferrable
73
Corp Gov best practices:
| Audit Committee
1) Audit comittee should consist of independent directors.
2) At least 2 members should have relevant acctg & auditing experience
3) Internal audit staff should report to audit committee directly
4) committee should meet with external auditors at least once annually w/o mgmt present
74
Comparables vs Comparable Transactions
Comparables: need to include control premium
Comparable Transactions: control premium included in multiple already
