Corporate Finance

Question 1

What are the two ways of comparing mutually exclusive projects in a replacement chain?

Answer 1

1) Least common multiple of lives

2) Equivalent annual annuity

Question 2

What is the formula for economic income?

Answer 2

Economic income = (EBIT(1-T) + D) - Change in market value

Question 3

What is the formula for economic profit?

Answer 3

Economic profit = EBIT(1-T) - $WACC

$: End of previous year

Question 4

What is the equivalent of Market Value Added (MVA?)

Answer 4

NPV

Question 5

What is the formula for residual income?

Answer 5

Residual income = NI - reBt-1

Question 6

What is the MM Proposition I (with taxes)?

Answer 6

VL = VU + tD

Question 7

What is the MM Proposition II (with taxes)?

Answer 7

Re = Ro + (Ro - Rd) (1-T) (D/E)

Question 8

What is the formula for capital available for project investment?

Answer 8

(1 + (%D/%E)) x (NI - Div)

Question 9

What is the formula for Expected DPS?

Answer 9

Previous DPS + (Increase in EPS x Target payout x Adjustment Factor)

Question 10

What is the goal of the capital structure decision?

Answer 10

Determine the financial leverage that maximizes the value of the company (or minimizes the WACC)

Question 11

What is the pecking order?

Answer 11

1) Internal financing
2) New debt
3) New equity

Question 12

What are the different dividend policies?

Answer 12

1) Stable divided
2) Constant payout ratio
3) Residual dividend policy

Question 13

What is the Friedmand doctrine?

Answer 13

Company’s purpose is to increase profit for shareholders

Question 14

What is the Utilitarian doctrine?

Answer 14

Consequences determine if action is moral or not

Most good for most people

Question 15

What does Kantian ethics promote?

Answer 15

Should not use people to get what you want

Question 16

What does the Rights theory promote?

Answer 16

Companies should not violate rights of any stakeholders

Question 17

What does the Justice theory promote?

Answer 17

Rawls: redistribution is justified

Question 18

What are the objectives of corporate governance?

Answer 18

1) Eliminate or mitigate conflicts of interest

2) Ensure that assets are used efficiently and productively in the best interests of investors and other stakeholders

Question 19

What are the core attributes of an effective corporate governance system?

Answer 19

1) Delineation of rights of shareholders and other core stakeholders
2) Clearly defined manager and director governance responsibilites
3) Identifiable and measurable accountabilities for the performance of responsibilities
4) Fairness and equitable treatment in all dealings
5) Complate transparency and accuracy in disclosures regarding operations, performance, risk and financial position

Question 20

How can we interpret the HH Index?

Answer 20

HHI Concentration Level
Post-Merger HHI Concentration Change in HHI Government Action
Less than 1,000 Not concentrated Any amount No action
Between 1,000 and 1,800 Moderately concentrated 100 or more Possible challenge
More than 1,800 Highly concentrated 50 or more Challenge

Question 21

What are the pre-offer defense mechanisms?

Answer 21

1) Poison pills
2) Poison puts
3) Incorporation in a state with restrictive takeover laws
4) Staggered board of directors
5) Restrictive voting rights
6) Supermajority voting provisions
7) Fair price amendments
8) Golden parachutes

Question 22

What are the different types of poison pills?

Answer 22

1) Flip-in: gives current shareholders right to purchase additional shares at a discount price BEFORE potential takeover
2) Flip-over: gives current shareholders right to purchase additional shares at a discount price AFTER potential takeover

Question 23

What is a dead-hand provision?

Answer 23

A poison pill provision that allows for the redemption or cancellation of a poison pill provision only by a vote of continuing directors (generally directors who were on the target company’s board prior to the takeover attempt).

Question 24

What is a poison put?

Answer 24

Allows bondholders to put the bonds to the company ; large cash outflow needed

Question 25

What is a golden parachute?

Answer 25

Compensation agreements between the target company and its senior managers. Allow the executives to receive lucrative payouts, usually several years’ worth of salary, if they leave the target company following a change in corporate control.

Question 26

What are the post-offer defense mechanisms?

Answer 26

1) Just Say No
2) Litigation
3) Greenmail
4) Share repurchase
5) Leverages recapitalization
6) Crown Jewel Defense
7) Pac-Man Offer
8) White Knight
9) White Squire

Question 27

What is a White Squire defense?

Answer 27

Find a friendly party to buy a minority stake enough to block the hostile takeover

Question 28

What is the Greenmail defense?

Answer 28

The target buys its own shares from the acquirer at a premium.

Question 29

What are the possible actions by a hostile acquirer?

Answer 29

1) Bear hug: bypass CEO and propose directly to the board
2) Tender offer: acquirer invites target shareholders to submit (“tender”) their shares in return for the proposed payment
3) Proxy fight: attempt to take control of a company through a shareholder vote

Question 30

How can we calculate synergies arising from a merger/acquisition when target pays with stock and cash?

Answer 30

1) Calculate # of shares of acquirer after the acquisition
- Original # of shares + (Targer # of shares * Exchange ratio)
2) Value of shares post-merger: New # of shares * New share price
3) Find synergies using formula:
Value of acquirer pre-merger + value of target pre-merger + synergies - cash paid = Value of shares post-merger

Question 31

How can we calculate the real cost of equity?

Answer 31

Real = ( (1 + Nominal) / (1 + Inflation) ) -1

Question 32

How can we calculate the marginal tax rate for shareholders based on dividend income?

Answer 32

Pw – Px = D × [(1 – TD)/(1 – TCG)]

Question 33

What are valid reasons for share repurchases?

Answer 33

1) Potential tax advantages
2) Added managerial flexibility
3) Offsetting dilution from employee stock option grants
4) Increasing financial leverage towards optimal
5) Signaling/share price support