Corporate Finance

Question 1

Corporate finance

Answer 1

Study of ways to answer questions:

1. Long-term investments - what lines of business will a firm be in, what machinery, buildings, equipment will it need?
2. Long-term financing - how will a firm pay for its investments? New owners or borrow money?
3. Everyday finances - how will a firm manage its everyday financing activities

Question 2

Financial manager

Answer 2

Managers who represent owners interests and make decisions on their behalf

Question 3

Financial managers are responsible for:

Answer 3

1. Financial health of organization
2. Produce financial reports
3. Direct investment activities
4. Develop strategies and plans for long-term financial goals of organization

Question 4

CFO

Answer 4

Chief Financial Officer

Coordinates activities of treasury, the controlling team and group

Question 5

Financial manager must be concerned with 3 topics

Answer 5

1. Capital budgeting
2. Capital structure
3. Working capital management

Question 6

Capital budgeting

Answer 6

Process of planning and managing a firm’s long-term investments

Question 7

Capital Budgeting tries to

Answer 7

Identify investment opportunities that are worth more that cost to acquire

Includes evaluating the size, timing and risk of future cash flows

Question 8

Capital Budgeting and Present Value

Answer 8

PV summarizes the value of cash flow stream in a single number

Takes into account that $ today is worth more than $ tomorrow
And
Safe $ is worth more than a risky $

Question 9

Capital structure

Answer 9

Aka financial structure

Specific mixture of long-term (debt financing) and equity (equity financing) the firm uses to finance operations

Question 10

Capital structure questions

Answer 10

How much should firm borrow
What mix of debt and equity is the best
What are least expensive sources of funds for the firm

Question 11

Capital Structure and Modigliani and Miller

Answer 11

Company’s projects’ value is independent of the choice between debt and equity

Question 12

Capital structure
Debt Financing

Answer 12

Have priority over equity holders, no voting rights

Question 13

Debt Financing

Different maturities

Answer 13

Loan maturity date refers to when borrower’s final loan payment is due

1-30 years

Question 14

Promissory note

Answer 14

Once all repayments are met, PN (record of the original debt) is retired

Question 15

Secured loan

Answer 15

Lender has no longer claim on borrower’s assets

Question 16

Fixed maturity date

Vs no fixed maturity

Answer 16

Specific date which instrument matures

Question 17

Serial maturity

Answer 17

Bonds are all issued at the same time but divided into different (staggered) maturity classes

Question 18

Fixed interest rate

Answer 18

Interest rate remains constant for the duration of the loan

Question 19

Floating (variable) interest rate

Answer 19

Interest rate fluctuates over the duration of the loan

—>. Moves in tandem with a particular index or benchmark or general market conditions (LIBIR, federal funds rate) ~> charge a spread over the benchmark

Question 20

Junior (subordinated) debt

Answer 20

Forms of debt issued with a lower priority for repayment

Riskier for investors —> higher interest rate

Question 21

Senior debt

Answer 21

Repaid first if the borrower encounters a default or liquidation

Lower risk —> lower interest payments

Question 22

Convertible bonds

Answer 22

Holder has option to convert/exchange bond for a predetermined number of shares

Question 23

Conversion price

Answer 23

Sensitive to changes in interest rates, price of the underlying stock and the issuer’s credit rating

Question 24

Conversion ratio

Answer 24

How many shares of stock investor can get from converting one bond

Question 25

Covenants

Answer 25

Agreements between company and its lenders, that company will operate within certain rules set by lenders

Protect lender - prohibiting borrower actions
Benefit borrower - reduces cost of borrowing

Question 26

Collateral

Answer 26

Borrower’s pledge of specific property to a lender to secure repayment of a loan

—> lower interest rate offer

Question 27

Collateralized debt obligation

CDO

Answer 27

Complex structured finance product that is backed by a pool of loans and other assets and sold to institutional investors

Question 28

Equity financing

Answer 28

Involves selling a portion of a company’s equity in return for capital

No interests -> no repaying

Question 29

Stockholders have

Answer 29

Residual claim on assets and cash flows
Right of control

Question 30

Modigliani & Miller I

Answer 30

With perfect capital markets and no taxes, the value of the firm is independent of its capital structure

Question 31

Modigliani & Miller II

Answer 31

The expected return on equity of a levered firm increases with the D/E ratio. The ratio of increase depends on the spread between the expected return on assets and the return on debit

Question 32

Working Capital Management

WCM

Answer 32

Optimization of costs tied up in or for operating assets

Question 33

Net Working Capital

NWC

Answer 33

Difference between current assets and current liabilities

Question 34

Liquidity

Answer 34

Firm’s ability to meet its financial obligations based on cash flows generated from its current operations

Question 35

Cash conversion cycle
CCC

Answer 35

Used to analyze and manage net working capital
Shows transformation of investments into cash inflows

Question 36

Agency relationship ms

Answer 36

Relationship between stockholders (principal) and management (agency)

Possibility of conflict of interest and information asymmetry.

Question 37

Agency relationship conflict

Answer 37

Agents tend to possess more info than principals

Moral hazard - employee (agents) can act in their interests at the principal’s expense