Corporate Finance Flashcards
What affects a capital structure?
Decisions on whether to accumulate cash, pay off debt or pay dividends.
D
market value of debt
E
Market value of equity
V=D+E
Market value of the firm
rD
expected return (cost of capital) of debt. Expected return demanded by investors who lend to the company
rE
expected return of equity
D/V
Firm’s debt to value ratio, is the fraction of the firm’s total value that corresponds to debt
Why does utilities have a higher average debt to value ratio of 50%?
Services are used frequently so they can afford this cuz cash flows are predictable.
Choice of D/V
tax benefits from claiming interest on debt
predictability of cash flow
How should a firm raise the funds it needs to undertake its investments?
Depends on the value the market applies to its security. The Valuation Principle tells us that the price of any securities issued by the
firm will be the present value of the cash flows accruing to them
Equity financing for private companies can seek funding from several potential sources…
Angel investors: Individual investors who buy equity in small private firms (often start up firms)
Venture Capital: Business that specializes in raising money to invest in the private equity of young firms (start ups)
Private Equity firms: Similar to VC, but invest in the equity of existing privately held firms rather than start up companies. Often initiate their investment by finding a publicly traded firm and purchasing all outstanding equity.
Raising equity capital using an IPO
Process of selling stock to the public.
Advantages: Going public provides companies with greater liquidity and better access to capital.
Disadvantage: Equity holders of the corporation become more widely dispersed. Investors’ ability to monitor the company’s management decreases.
Seasoned Equity Offering
A public company’s return to the equity markets with an offer of new shares for sale. When issuing stock using an SEO, a firm follows many of same steps as IPO. Compared to IPO not as unsure of what the share price should be.
Debt Financing
Does not dilute the ownership of the firm. But loan must be repayed. The firm is legally obligated to make interest and principal payments on its
debt. If it fails to do so, it is in default and can be forced into bankruptcy
Corporate debt can be
Private Debt: negotiated directly with a bank or a small group of investors
Public Debt: Trades in a public market (Bonds)
Public Corporate debt
public bond issue is similar to stock issue. Firm provides an indenture to the market, a formal contract that specifies the firms obligation to bondholders. They almost always pay coupons semi-annually & have maturity of 30 years or less.
Unsecured Debt
In the event of bankruptcy, bondholders have a claim to only the assets of the firm that are not already pledged as collateral on other debt
Secured Debt
Specific Assets are pledged as collateral that bondholders have a direct claim to in the event of a bankruptcy. Mortgage bonds are an example of secured corporate debt in which real
property is pledged as collateral
Corporate Debt seniority
priority is seniority.When a firm conducts a subsequent debenture issue that has lower priority than
its outstanding debt, that is called a subordinated debenture.
What is capital budgeting?
Process of allocating the firm’s capital for investment is known as capital budgeting
What is the value of an investment?
The present value of a stream of future cash flows generated by the assets/project.
Net present value rule
When choosing among investment alternatives, take the alternative with the highest NPV.
Accept positive-NPV projects; accepting them is equivalent to adding the NPV value to the firm today
Reject negative-NPV projects; accepting them would reduce the value of the firm
Net present value formula
True or False discount rate is extremely important in capital budgeting
True: higher project risk, higher discount rate (risk and return)
