Corporate finance

Question 1

5 principles of capital budgeting

Answer 1

1) Decision is based on cash flows, not accounting income
1. 1) Sunk cost are not included into the analysis
2) Cash flows are based on opportunity costs
3) The timing of cash flows is important
4) Cash flows are calculated at the after-tax basis
5) Financing costs are reflected in discounting rates

Question 2

MACRS basics

Answer 2

1) 5 asset classes 3y, 5y, 7y, 10y and 39y (real estate)
2) Assets are placed in service in the middle of the first year
3) Depreciable basis is not adjusted for salvage value

Question 3

Types of project cash flows

Answer 3

1) Initial investment outlay = FCInv + NWCInv
NWC = d(non-cash CA) - d(non-debt CL)
2) Operation cash flows = (S - C - D)(1 - T) + D
Depreciation is added back as it is tax-deductible
3) Terminal year non-operating cash flow = Sal(T) + NWCInv - T*(Sal(T) - Book(T))
Sal and Book - pre-tax cash proceeding from sale of fixed assets and their book value

Question 4

Effects of inflation

Answer 4

1) Reduce of tax shelter from depreciation

2) Decrease payments to bondholders

Question 5

How to asses mutually exclusive projects with different lives

Answer 5

1) Least common multiple of live approach - extend project lives to a common multiple and calculate NPV
2) Equivalent annual annuity approach - calculate PMT and compare

Question 6

Economic and accounting income of a project

Answer 6

1) Economic = cash flow - d(Market value of investment)
Market value of investment = NPV of remaining cash flows
2) Accounting = see PnL

Question 7

Claims valuation approach

Answer 7

Alternative approach for valuation of a company
CF to bondholders = Principal payments = Interest expense
CF to shareholders = CFO(NI + Dep) - Principal payments

Question 8

Modigliani-Miller proposition on cost of equity

Answer 8

r_eq = r_unlev + D/E(r_unlev - r_debt)

Question 9

Expected dividend under the stable dividend policy

Answer 9

current dividend + d(EPS)target payout ratio(1/years_adjust)

Question 10

HHI - measure of market concentration

Answer 10

1800 - highly concentrated

If M&A lead to dHH > 100 it is usually subject for antitrust actions

Question 11

FCF calculation for M&A

Answer 11

FCF = NOPLAT + NNC - FCInv - WCInv
NOPLAT = Unlevered NI +/- change in deferred taxes
Unlevered NI = NI + net interest after tax