Corp. Finance Flashcards
Cash Flow Estimation for Expansion Projects
After-tax operating cash flow (
CF=(S−C−D)(1−T)+D
=(S−C)(1−T)+(TD)
Terminal year after-tax non-operating cash flow (TNOCF).
TNOCF = SalT + NWCInv − T (SalT − BT)
=Initial inv. - cumulative depr
= Ps - T(ps-(initial inv. cumu. depr)
= ps- capital gain taxes
Cash Flow Estimation for Replacement Projects
-fcinv-nwinc
+(salt-t(sal0-bo))
real option
give the option holder the right, but not the obligation, to make a decision.
The difference is that real options are based on real assets rather than financial assets and are contingent on future events. Real options offer managers flexibility that can increase the NPV of individual projects.
= npv( real option) - npv( real economy)
economic income
economic income = after-tax cash flow − economic depreciation
=ebit(1-t)+accounting depr-change in mkt value
economic depreciation = (beginning market value − ending market value)
=CF1(1-T)- (VO-V1)
accounting income
Accounting income is the reported net income on a company’s financial statements that results from an investment in a project.
= rev - exp
= (ebit-wacc)(1-t)
economic profit
NOPAT − $WACC =EBIT(1-T) - WACC*R
capital = initial investment - depr
Residual income
Net income less an equity charge
v= B0+ (1+ROE-R)/(R-G)
Claims valuation
separates cash flows based on the claims that equity holders and debt holders have on the asset.
value of com.=value of liability + value of equity
MM Proposition I (No Taxes)
—capital structure is irrelevant; value of the firm is unaffected by the capital structure. VL = VU
MM Proposition II (No Taxes)
—the cost of equity increases linearly as a company increases its proportion of debt financing. The benefits from using more debt are exactly offset by the rise in the cost of equity, resulting in no change in the firm’s WACC.
re= r0+(r0-rd)d/e
MM Proposition I (With Taxes)
—Value is maximized at 100% debt; the tax shield provided by debt causes the WACC to decline as leverage increases.
VL = VU + (t × d)
value of unlevered ( all equity) com. = EBIT(1-T)/rwacc
MM Proposition II (With Taxes)
—WACC is minimized at 100% debt; the tax shield provided by debt causes the WACC to decline as leverage increases.
RE= r0-(r0-rd)(1-t)D/E
Pecking order theory
states that managers prefer financing choices that send the least visible signal to investors, with internal capital being most preferred, debt being next, and raising equity externalstates that managers will try to balance the benefits of debt with the costs of financial distress.
Static trade-off theory
seeks to balance the costs of financial distress with the tax shield benefits from using debt, and states there is an optimal capital structure that has an optimal proportion of debt.
VL = VU + tD - pv(cost of financial distress)
Cost of financial stress vL
VL = VU + (t × d) − PV(costs of financial distress)
Double taxation
effective rate = corporate tax rate + (1 − corporate tax rate) × (individual tax rate)
expected increase in dividends
=[(expected earnings×target payout ratio)
−previous dividend]
×
adjustment factor
split-rate corporate tax system
taxes earnings distributed as dividends at a lower rate than earnings that are retained. The effect is to offset the higher (double) tax rate applied to dividends at the individual level.
dividend coverage ratio
= net income / dividends
FCFE coverage ratio
= FCFE / (dividends + share repurchases)
Bootstrapping
is a technique whereby a high P/E firm acquires a low P/E firm in an exchange of stock.
The total earnings of the combined firm are unchanged, but the total shares outstanding are less than the two separate entities. The result is higher reported earnings per share, even though there may be no economic gains.
Pre-offer defense mechanisms:
Poison pills. Poison puts. Reincorporating in a state with restrictive takeover laws. Staggered board elections. Restricted voting rights. Supermajority voting. Fair price amendments. Golden parachutes.
Post-offer defense mechanisms:
"Just say no" defense. Litigation, greenmail. Share repurchases. Leveraged recapitalizations. "Crown jewel" defense. "Pac-Man" defense. Finding a white knight or white squire.
Discounted Cash Flow adv
It is relatively easy to model any changes in the target company’s cash flow that may occur after the merger.
It is based on forecasts of fundamental conditions in the future rather than on current data.
It is easy to customize.
Discounted Cash Flow disadv
The model is difficult to apply when free cash flows are negative.
Estimates of cash flows and earnings are highly subject to error, especially when those estimates are for time periods far in the future.
Discount rate changes over time can have a large impact on the valuation estimate.
Estimation error is a major concern since the majority of the estimated value for the target is based on the terminal value, which is highly sensitive to estimates used for the constant growth rate and discount rate.
Post-merger valuation for an acquirer
VAT = VA + VT + S − C
Gains accrued to the target
gainT = TP = PT − VT
Gains accrued to the acquirer
gainA = S − TP = S − (PT − VT)
Cash divestitures
involve a direct sale of a division to an outside party in exchange for cash.
divestiture would allow the buyer to consolidate market share
Equity carve-outs
create a new independent company by giving a proportionate equity interest in a subsidiary to outside shareholders through a public offering of stock.
replacement project
initial outlay
-FCINV - NWinc
+ (sal0 - t(sal0-b0))
cost of new machine + proceeds/loss from old machine + change in net working capital (NWC)
replacement project
annual after tax op. cf
cf= (change in s-c)(1-t) T * change in D
replacement project
terminal year after tax non-op cf
TNOCF= Chng in SalT + NWCInv - T(chng Salt- chng Bt)
real rate
1+nomial / 1+ inflation -1
nominal rate
real + Exp(inflation)
profitability index PI
=1 + NPV/Initial investment
total value of company
= initial investment + NPV
=origianl equity investment + origianl debt investment + npv
re (unlevered)
ro + (ro-rd)D/E
V
= D+ E
= interest payment on debt / rd
+ (EBIT- Interest payment on debt) / re
impact of cash dividend
reduce asset, reduce equity
increase financial leverage
reduce liquidity
cash flow from share sold before ex-dividend
cf= Ps - capital gains tax
= s - (s - purchase price)*tcg
annual after-tax operation cash flow
=(s-c-d)(1-t)+d
=(s-c)(1-t)+td
change in price when cf from sale before & after are the same
pw-px=d(1-td)/(1-tcg)
BVPS/EPS after buyback
if cost >yld of shares, shares repurchase reduces EPS
= total earnings- after tax cost of repurchase
/shares out after buyback
expected dividend D1 stable dividend (dividend amount stale)
= Do+ (E1* targeted DPS - D0)*adj factor
=change in dividend/ change in E * adj
residual dividend policy
div = earnings - (capital budget * equity%* in capital structure)
result in highly volatile dividend pmt
div coverage ratio
ni/div
=1/dps
the greater the dps, the greater the risk for delivery earning in dividend
fvfe coverage
fcfr/ (dvd+shares repurchases)
constant dps
dividend fluctuate with earnings in short term
increase at a constant rate
take over premium
(DP-SP)/SP
Dispersed ownership & dispersed voting power
- shareholders do not hold power over managers
- principal agent conflict is likely
- -shareholders want their value maximized
- -managers may use firm’s resources to their own advantages
weak shareholders, strong manager
high risk of principal agent
concentrated ownership and voting power
strong shareholder power over minority shareholders and weak managers
allow controllng shareholders to control the R&D;
effective control and monitor mgmt
strong shareholder, weak manager
low risk of principal agent
drawback - poor transparency
lack of mgmt accountability
moderate consideration for minority shareholder rights
difficulty in attract if quality-talent for mgmt positions
clawback policies
allow firms to reclaim past compensation if inappropriate conduct comes to light later
say-on-pay
give stakeholders the opportunity to vote on executive compensation
esg factors
- esg data provider
- industry organizations
- proprietary methods
ESG IN F1
mitigate downside risk
ESG in equity
mitigate downside risk
identifying potential opportunities
ESG impact on financial performance
increase costs to comply with regulatory requirements
potential times for violate clean air regulations
damage to corp.reputation that could potentially decrease sales
inflation
reflected in nominal rate
decrease value of pmt to bondholders
EAA
diff lives, equal annual pmt=npv
calculate pmt
Least common multiple
common multiple
calculate npv
The bird-in-hand argument for dividend policy argues
that a stock’s required return will decrease
and price will increase as the dividend payout increases. Investors are more certain about dividend payments relative to capital gains, and require a lower rate of return for stocks that have a higher dividend payout ratio.
Under an imputation tax system
taxes are paid at the corporate level, but are attributed to the shareholder, so that all taxes are effectively paid at the shareholder rate.
market value added
sum pv of EP/WACC
sum pv of RI/Re
