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CFA L2 2015 > Corp Fin > Flashcards

Corp Fin Flashcards

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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
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2
Q

Forms of integration

A

Statutory merger
Subsidiary merger
Consolidation

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3
Q

Industry lifecycle stages

A
  1. Pioneering development
  2. Rapid accelerating growth
  3. Mature growth
  4. Stabilization & mkt maturity
  5. Deceleration of growth & decline
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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
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5
Q

Rapid accelerating growth

A

Horizontal merger, Conglomerate

(High profit margins, low competition)

• Meet capital requirements for expansion

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6
Q

Mature growth

A

Horizontal, vertical

(Decrease in new entry, growth potential remains)

• for economies of scale, savings & operational efficiencies

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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
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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
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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
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10
Q

Pre-Takeover defense

A
  1. Poison pills/puts
  2. Incorporate in state with restrictive takeover laws
  3. Staggered BoD
  4. Restricted voting rights
  5. Supermajority voting provision
  6. Fair price amendments
  7. Golden parachutes
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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

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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

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13
Q

Restricted voting rights

A

(Pre-Takeover defense)

Precludes shareholders who recently purchased large block of shares from exercising voting rights

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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%)

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15
Q

Fair price amendments

A

(Pre-Takeover defense)

Changes to the corporate charger which only allows mergers with offer price > threshold

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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

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17
Q

Post takeover defense

A
  1. Just say no
  2. Litigation
  3. Greenmail
  4. Share repurchase
  5. Leveraged recap
  6. Crown jewel defense
  7. Pac Man defense
  8. White knight/squire defense
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18
Q

Litigation

A

(Post takeover defense)

Go to court for violation of antitrust or securities laws

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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

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20
Q

Share Repurchase

A

(Post takeover defense)

Raises share price

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21
Q

Leveraged recap

A

(Post takeover defense)

Issues lg debt to repurchase shares

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22
Q

Crown Jewel

A

(Post takeover defense)

Sells off valuable asset to make firm less attractive

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23
Q

Pac Man

A

(Post takeover defense)

Target attempts hostile takeover of acquirer (rare)

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24
Q

White knight

A

(Post takeover defense)

Encourages 3rd firm to acquire target (more acceptable to target mgmt)

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25
Q

White squire

A

(Post takeover defense)
3rd party purchase substantial minority stake (large enough to block takeover)

Risk of litigation here

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26
Q

Herfindahl Hirschman Index (HHI)

A

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)

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27
Q

Basic forms of restructuring

A

Equity carve out
Spin-off
Split-off
Liquidation

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28
Q

Equity carve out

A

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

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29
Q

Spin-off

A

Separates 1 of divisions to create new entity but shares are proportionally issued to current shareholders

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30
Q

Split-off

A

Separates 1 of divisions to create new entity and offers current shareholders shares in new entity in exchange for parent

31
Q

2 objectives of corp gov

A
  1. Eliminate conflicts of interest

2. Ensure company assets are used in best interest of investors & stakeholders

32
Q

Effective corp gov system has:

A
  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
Q

BoD has responsibility to:

A
  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
Q

Staggered boards are good/bad for corp gov?

A

Good, allows continuity of knowledge & experience

35
Q

Stakeholder impact analysis (SIA)

A
  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
Q

Philosophical approach to ethics

A
  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
Q

Dividend irrelevance theory (dividends don’t matter)

A

Homemade dividends

38
Q

Bird in hand (dividend matters)

A

Prefer current dividends over equal amt of potential capital gains from reinvesting earnings (uncertainty)

39
Q

Tax argument (dividend matters)

A

Higher tax on dividends than capital gains means preference for reinvesting earnings

40
Q

Dividend imputation system

A

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
Q

Split rate tax system

A

Earnings distributed as div are taxes lower than earnings retained by company. Div taxed again at shareholder lvl.

42
Q

3 dividend policies

A
  1. Stable
  2. Constant
  3. Residual
43
Q

Stable dividend policy

A

Companies seek to increase dividends each year at a constant rate

44
Q

Constant dividend policy

A

Keep constant dividend payout ratio

Dividends will vary with earnings, more volatile and a higher risk premium attached

45
Q

Residual dividend policy

A

1st use internally generated funds to finance investments in positive NPV projects consistent with target capital structure

Remaining funds distributed entirely as dividends

46
Q

Pros of share repurchases

A 
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
Q

Effects of share repurchases

A

If borrowed funds are used to finance repurchase:

the after tax Rd > earnings yield, EPS FALLS

the after tax Rd

48
Q

Effects of share repurchase on BV

A

When mkt price > BVPS, BVPS FALLS after repurchase

When mkt price

49
Q

Jensen’s FCF hypothesis

A

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
Q

MM1 (w/o taxes) : capital structure irrelevance

VL = VU

A
  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
Q

MM2 (w/o taxes): higher financial lvg raises Re

A

Re = Ro + (Ro - Rd)*(D/E)

The cost of equity is a linear function of the company’s debt/equity ratio

52
Q

MM2 (w/o taxes): equity beta

A

Beta(E) = Beta(A) + [Beta(A) - Beta(D)]*(D/E)

Equity beta increases as D/E ratio increases

53
Q

MM1 (with taxes)

VL = Vu + (D)*(t)

A

With taxes, and no costs of financial distress & bankruptcy, debt offers tax benefits.

Value of company increases when more debt is issued

54
Q

MM2 with taxes

A

Re = Ro + (Ro - Rd)(1-t)(D/E)

Company value increases when more debt is issued

55
Q

Agency Costs

A
  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
Q

Pecking Order theory (costs of asymmetric info)

A

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
Q

Static-Trade off theory (optimal capital structure)

A

After Acctg for costs of financial distress,

VL = VU + (t)*(D) - PV(costs of financial distress)

58
Q

International diff in capital structure

A

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
Q

Effects of inflation on capital budgeting

A

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
Q

Expected inflation & WACC

A

Increase in expected inflation will increase WACC

61
Q

2 methods for finding NPV of mutually exclusive projects with unequal lives

A
  1. Lease common multiple of lives approach

2. EEM

62
Q

NPV vs IRR

A

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
Q

Capital Rationing

A

Start with highest PI to lowest

64
Q

Sensitivity, scenario & Monte Carlo analysis

A
  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
Q

Monte Carlo analysis

A

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
Q

Diff between Acctg and economic income

A

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
Q

3 diff valuation approaches in capital budgeting

A
  1. Economic profit/WACC
  2. Residual income/Re
  3. Claims valuation/Rd, Re separate

All should lead to the same value

68
Q

4 Risks

A

1) Asset risk
2) Liability risk
3) Financial disclosure (acctg risk)
4) Strategic policy risk

69
Q

BoD best practices:

Composition of Board

A

75% of board members are independent

70
Q

BoD best practices:

Chairman

A

Independent

Chairman CEO

71
Q

BoD best practices:

Election

A

Annual re-election

72
Q

BoD best practices:

Meetings

A

requires independent board members to meet in separate sessions AT LEAST annually; qtrly is preferrable

73
Q

Corp Gov best practices:

Audit Committee

A

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
Q

Comparables vs Comparable Transactions

A

Comparables: need to include control premium

Comparable Transactions: control premium included in multiple already

CFA L2 2015 (7 decks)

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