Corp Finance Flashcards
Economic income
After-tax cash flows +/- change in project’s market value
Economic profit
= NOPAT - $WACC
Indicates return to all providers of capital
Residual income
= Net income - equity charge
= NI - Re(BVe)
Return to equity holders
Value of a firm (static trade-off theory)
Value of unlevered firm + debt shield - PV(costs of financial distress)
MM proposition I (no taxes)
Capital structure of the firm is irrelevant
MM proposition II (no taxes)
WACC does not change because increases in use of debt is offset by higher cost of equity
MM proposition (with taxes)
Tax shield makes debt preferred form of financing with WACC minimized when 100% debt
What percent of a board of directors should be comprised of independent members?
75% who should meet at least once a year apart from the management
Who should the internal audit staff report to?
Audit committee that consists of only independent board members
How does EPS bootstrapping work?
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
Herfindahl-Hirschman Index
Sum of (100*mkt sh)^2 for all firms in the industry
What may trigger antitrust action?
- Post-merger HHI of 1000-1800
- Change in HHI of 100 or more
What will certainly trigger antitrust action?
- Post-merger HHI > 1800
- change in HHI of 50
What methods should be used to assess mutually exclusive projects?
- equivalent annual annuity
- replacement chain
How much is paid in dividends under the residual dividend model?
Earnings - (E/A)*(capital budget financed with equity)
How much is paid in dividends under the stable dividend model?
Previous dividend + (Expected increase in EPS x target payout ratio x 1/years)
Move towards target payout
Objectives of corporate governance
- 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
What is the downside of the constant payout ratio approach for dividends?
Company pays out a proportion of earnings regardless of volatility in earnings
What are the disadvantages of the residual dividend policy?
- dividends fluctuate with investment opportunities and earnings
- uncertainty results in higher required return and lower valuation
Compare comparable company approach to comparable transaction approach
- 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
Compare carve-outs to spin-offs to split-offs
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
How does a stock acquisition affect shareholders vs a cash acquisition?
In a stock transaction, acquirer dilutes shares by issuing new shares to buy the target
