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CFA Exam Level 1 > Corporate Finance > Flashcards

Corporate Finance Flashcards

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1
Q

The mechanism of aligning the interests of shareholders and management, is known as…?

A

Corporate governance

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2
Q

What is the difference between shareholder theory and stakeholder theory?

A

Shareholder theory: Corporate governance is only in place to mitigate conflicts of interests between shareholders and management

Stakeholder theory: Corporate governance is also in place to mitigate the conflicts of interests of management and wider stakeholders

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3
Q

Who are the stakeholders of a business?

A

Shareholders, employees, suppliers, and customers, among others

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4
Q

What is the difference between a two-tier board and one-tier board structure?

A

In the traditional two-tier board structure, a separate board of supervisory directors “supervises” and oversees the board of managing directors and gives advice to the managing directors.
In a one-tier board structure, the executive directors and non-executive, supervising, directors are all members of one and the same board, i.e. they jointly form a single corporate body.

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5
Q

What is the principal agent conflict?

A

Principal-agent conflict: An agent’s interests may not coincide exactly with those of the principal

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6
Q

What happens at an AGM?

A

AGM: Management release audited FS, address company performance and answer shareholder questions

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7
Q

Recall and describe the four stakeholder management infrastructures?

A
  1. Legal
  2. Contractual
  3. Organisational
  4. Governmental
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8
Q

Who can attend an AGM?

A

Any shareholder can attend an AGM

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9
Q

What happens to a shareholders vote if he/she cannot attend?

A

If a shareholder cannot attend to vote they can give up their vote through proxy.

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10
Q

What is the difference between ordinary and special resolutions?

A

Ordinary resolutions require >50% e.g. approval of auditor and the election of directors

Special resolutions require >75% e.g. mergers, takeovers or amending company bylaws

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11
Q

Special meetings which occur on an ad hoc basis where special resolution votes are required ie takeovers / mergers and amendments to company bylaws are known as…?

A

Extraordinary general meetings

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12
Q

Are Directors are allowed to vote on transactions in which they have a material interest?

A

No

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13
Q

A board made up of different types of directors that are elected at different times of the year.

A

Staggered board

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14
Q

Are the board of directors involved in day to day management?

A

No

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15
Q

Who is cumulative voting most advantageous for?

A

Minority voters because they can use all of their votes for a single candidate

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16
Q

Who are activist shareholders?

A

Activist Shareholders: Activists take stakes in businesses and seek changes in management and objectives to increase their return by increasing shareholder value

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17
Q

A takeover not supported by management is called?

A

Hostile takeover

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18
Q

What are the risks of poor corporate governance?

A

Weak internal controls
Managers unmonitored may make generally poor investment decisions or choose lower than optimal risk
Legal and reputational risks

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19
Q

What are the issues with ESG investing?

A

A manager has a fiduciary responsibility to act in the best financial interests of the client, integrating ESG investments may conflict with this

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20
Q

What is the difference between negative and positive screening?

A

Negative screening: Excluding companies in a portfolio that do not comply ESG criteria.

Positive screening: Integrating companies in a portfolio that follow ESG practices

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21
Q

What is best in class investment?

A

Best-in-class investment: Investing in companies that are leaders in ESG criteria in their asset class

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22
Q

What is impact investing?

A

Impact investing: Investments “made into companies, organizations, and funds with the intention to generate a measurable, beneficial social or environmental impact alongside a financial return”

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23
Q

What is thematic investing?

A

Thematic investing: Investment through Identify investments from wider macroeconomic trends

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24
Q

Detail the four steps of the capital budgeting process?

A

💡Idea Generation
🖥️Analysing project proposals
💲Create a firm wide capital budget
✅Monitor decisions and conduct a post-audit

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25
Q

What are some examples of capital budgeting projects?

A

Replacement projects to maintain the day to day running of the company
Expansion projects
M&A
New product or market development

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26
Q

The costs that cannot be recovered even if the project is not undertaken are defined as…?

A

Sunk costs

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27
Q

Are sunk costs included in NPV analysis?

A

Sunk costs are excluded from NPV analysis

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28
Q

What are externalities?

A

Externalities: Impact of acceptance of a project on other project cash flows within the firm

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29
Q

What is the difference between a conventional and unconventional cash flows?

A

Conventional Cash flow have only one change in sign of the cash flows across the life of the project

Unconventional cash flow have more than one change in sign of cash flow across the life of the project

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30
Q

The cash flows that a firm will lose by undertaking the opportunity / project in question are defined as…?

A

Opportunity costs

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31
Q

How are financing costs baked into NPV computations?

A

Financing costs are baked into the discount rate so do not need to be reflected in the incremental cash flows

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32
Q

What is the difference between an independent and a mutually exclusive project?

A

Independent projects: Projects that are unrelated to each other and allow for each project to be evaluated on a standalone basis

Mutually exclusive: Only one project in a set of possible projects can be accepted

33
Q

What is the formula for the NPV?

A

( NPV = -CF_0 + \frac{CF_1}{(1+k)^1} + \frac{CF_2}{(1+k)^2} +….+ \frac{CF_n}{(1+k)^n} )

34
Q

What is the decision rule for independent and mutually exclusive projects?

A

Independent projects decision rule — > Accept any project with a positive NPV

Mutually exclusive projects decision rule — > Accept the project with the greatest NPV

35
Q

What is the formula for the IRR?

A

NPV = 0

36
Q

What is the decision rule for the IRR?

A

If COC < IRR accept the project

If COC > IRR reject the project

37
Q

How do you calculate the payback period?

A

(Payback\ period = Time\ until \ break even + \frac{Unrecovered\ cost\ at\ break\ even}{Total\ cash\ flow\ at\ break\ even})

38
Q

What are the main drawbacks of the payback period?

A

It does not take into account either the time value of money or cash flows beyond the payback period

39
Q

How do you calculate the discounted payback period?

A

( Discounted\ payback\ period = Time\ until\ discounted\ cash\ flows\ break\ even + \frac{Unrecovered\ discounted\ cost\ at\ break\ even}{Total\ discounted\ cash\ flow\ at\ break\ even} )

40
Q

What is the formula for the profitability index?

A

(Profitability\ index = 1 + \frac{NPV}{C_0})

41
Q

What is the decision rule for the profitability index?

A

Decision rule accept if > 1, Reject if < 1

42
Q

Where does the NPV crossover rate occur?

A

NPVA = NPVB

43
Q

At what rate are cash flows reinvested at in NPV comps?

A

The cost of capital

44
Q

At what rate are cash flows assumed to be invested at in the IRR comp

A

At the IRR

45
Q

Which tool is best for unconventional cash flows, NPV or IRR?

A

NPV

46
Q

What is the point at which an NPV profile graph intersecting the vertical axis best described as?

A

The sum of the undiscounted cash flows

47
Q

What is the point at which an NPV profile graph intersecting the horizontal axis best described as?

A

IRR

48
Q

What is the relationship between NPV and share price?

A

( New\ share\ price = \frac{(Value\ of\ firm\ before\ project + NPV)}{Number\ of\ shares\ outstanding} )

49
Q

What is the formula for the WACC?

A

( WACC = W_dK_d(1-t) + W_pK_p + W_{ce}K_{ce} )

50
Q

Why do we deduct the tax of the cost of debt?

A

Interest on debt is tax deductible

51
Q

What is Kd?

A

Market interest rate of new debt

52
Q

What are the weights in the WACC comp based on?

A

The weights are based on the firm’s target capital structure

53
Q

What is the point called on the investment opportunity schedule chart where the IRR intersects the marginal cost of capital

A

Optimal capital budget

54
Q

What is the formula for the cost of preference stock?

A

( K_p = \frac{D_0}{P_0} )

55
Q

What are the three methods to calculating Ke?

A
  1. CAPM
  2. DDM
  3. Bond yield plus risk pm approach
56
Q

What is the formula for the CAPM?

A

( CAPM = R_f + \beta (R_m - R_f) )

57
Q

What is the formula for the DDM?

A

( P_0 = \frac{D_0 (1+g)}{(K_e -g)} )

58
Q

What is the formula for the bond yield plus risk pm approach to calculating Ke?

A

Ke = YTM + Risk Premium

59
Q

What is the pure play method for estimating beta?

A

Using the beta of a comparable publicly traded company and adjusting the beta so that it takes into account the financial risk of a non-listed company

60
Q

What is a Country risk premium?

A

A risk premium included in CAPM to capture the risk of developing countries

61
Q

What is the formula for country risk pm?

A

( CRP = Sovereing\ yield\ spread \times \frac{Standard\ deviation\ of\ equity\ index}{Standard\ deviation\ of\ bond\ index} )

62
Q

What is the correct treatment of flotation costs?

A

Treat as a cash outlay in year 0 in the NPV computation

63
Q

The amount of fixed cost a firm has in relation to its overall cost base is defined as?

A

Gearing (leverage)

64
Q

What is the difference between operating leverage and financial leverage?

A

Operating leverage increases with fixed operating costs. e.g. building or equipment leases

Financial leverage increases with fixed financing costs. e.g. Interest payments on long term debt

65
Q

What 2 risks makeup business risk

A
  1. Sales risk

2. Operating risk

66
Q

How do you calculate degree of operating leverage?

A

DOL = % change in EBIT / % change in sales

67
Q

How do you calculate degree of financial leverage?

A

DFL = %Change in EPS / % change in EBIT

68
Q

What is the formula for the degree of total leverage?

A

DTL = DOL*DFL

69
Q

What is the formula for the break even point (in units)?

A

( BEP(u) = \frac{Total\ fixed\ costs}{Contribution\ per\ unit} )

70
Q

What is the formula for operating break even point (in units)?

A

( Operaing BEP(u) = \frac{Operating\ fixed\ cost}{Contribution\ per\ unit} )

71
Q

What is the formula for break even point (in sales)?

A

BEP (sales) = BEP(u) x Price per unit

72
Q

What is the difference between primary and secondary sources of liquidity?

A

Primary sources of liquidity are used for everyday operations, whereas secondary sources of liquidity are not typically called upon for the everyday circumstance

73
Q

What are some differences between drags and pulls on liquidity?

A

Drags on liquidity: Lags on cash inflows. For example obsolete inventory, uncollected trade receivables

Pulls on liquidity: Shorten cash outflows. For example paying vendors sooner than is optimal

74
Q

What is the formula for the operating cycle?

A

Operating cycle = Inventory days + Trade receivables days

75
Q

What is the formula for the cash conversion cycle?

A

Cash conversion cycle = Inventory days + Trade receivables days - Trade payables days

76
Q

What is the formula for the bond equivalent yield?

A

( BEY= (\frac{Face\ value - Price}{Price}) (\frac{365}{Days\ to\ maturity}) )

77
Q

What is the formula for the cost of trade credit?

A

( Cost\ of\ trade\ credit = (1+ \frac{discount\ percentage}{1- discount\ percentage})^{\frac{365}{Days\ past\ discount}} -1)

78
Q

What is commercial paper?

A

Commercial Paper: Debt issued by large, creditworthy corporates

79
Q

Sale of trade receivables at a discount to improve liquidity is called?

A

Debt factoring

CFA Exam Level 1 (10 decks)

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