Corp Finance

Question 0

Economic income

Answer 0

After-tax cash flows +/- change in project’s market value

Question 1

Economic profit

Answer 1

= NOPAT - $WACC

Indicates return to all providers of capital

Question 2

Residual income

Answer 2

= Net income - equity charge
= NI - Re(BVe)

Return to equity holders

Question 3

Value of a firm (static trade-off theory)

Answer 3

Value of unlevered firm + debt shield - PV(costs of financial distress)

Question 4

MM proposition I (no taxes)

Answer 4

Capital structure of the firm is irrelevant

Question 5

MM proposition II (no taxes)

Answer 5

WACC does not change because increases in use of debt is offset by higher cost of equity

Question 6

MM proposition (with taxes)

Answer 6

Tax shield makes debt preferred form of financing with WACC minimized when 100% debt

Question 7

What percent of a board of directors should be comprised of independent members?

Answer 7

75% who should meet at least once a year apart from the management

Question 8

Who should the internal audit staff report to?

Answer 8

Audit committee that consists of only independent board members

Question 9

How does EPS bootstrapping work?

Answer 9

High P/E firm acquires low P/E firm with stock and ends up with a higher EPS because # of shares is less than the sum of the combined firms

Question 10

Herfindahl-Hirschman Index

Answer 10

Sum of (100*mkt sh)^2 for all firms in the industry

Question 11

What may trigger antitrust action?

Answer 11

• Post-merger HHI of 1000-1800

- Change in HHI of 100 or more

Question 12

What will certainly trigger antitrust action?

Answer 12

• Post-merger HHI > 1800

- change in HHI of 50

Question 13

What methods should be used to assess mutually exclusive projects?

Answer 13

• equivalent annual annuity

- replacement chain

Question 14

How much is paid in dividends under the residual dividend model?

Answer 14

Earnings - (E/A)*(capital budget financed with equity)

Question 15

How much is paid in dividends under the stable dividend model?

Answer 15

Previous dividend + (Expected increase in EPS x target payout ratio x 1/years)

Move towards target payout

Question 16

Objectives of corporate governance

Answer 16

• eliminate or reduce conflicts of interest
• ensure the company uses company assets in a manner consistent with the best interests of investors and other stakeholders

Question 17

What is the downside of the constant payout ratio approach for dividends?

Answer 17

Company pays out a proportion of earnings regardless of volatility in earnings

Question 18

What are the disadvantages of the residual dividend policy?

Answer 18

• dividends fluctuate with investment opportunities and earnings
• uncertainty results in higher required return and lower valuation

Question 19

Compare comparable company approach to comparable transaction approach

Answer 19

• Comparable company approach uses market data from similar firms and adds a takeover premium
• Comparable transaction approach uses data from transactions completed by similar firms

Question 20

Compare carve-outs to spin-offs to split-offs

Answer 20

Carve-outs offer equity interest in a new company to outside investors

Spin-offs offer equity interest in a new company to existing investors

Split-offs offer existing investors the opportunity to exchange current shares for shares in new company

Question 21

How does a stock acquisition affect shareholders vs a cash acquisition?

Answer 21

In a stock transaction, acquirer dilutes shares by issuing new shares to buy the target