Corporate Finance

Question 1

There are three incremental cash flows to be identified when evaluating a capital project:

Answer 1

1. Initial Investment Outlay
2. After Tax Cash Flows from Operations
3. Terminal Year after-tax non operating cash flows

Question 2

Initial Investment Outlay

Answer 2

= FCinv+WCinv

Question 3

After-Tax Cash Flows from Operations

Answer 3

= (S-C-D)*(1-T) + D
= (S-C)(1-T) + (T*D)
where,
S = Sales
C = Cash Operating Costs
D = Depreciation Expense
T = Marginal Tax Rate

Question 4

Terminal Year After-Tax Non-Operating CFs

Answer 4

TNOCF = SalT + WCinv - T(SalT - Bt)
where,
SalT = pretax cash proceeds from sale of fixed capital
Bt = book-value of the fixed capital sold

Question 5

Economic Income

Answer 5

= cash-flows + (ending market value - beginning market value)
= cash flow - economic depreciation

Question 6

Accounting Income differs from economic income by:

Answer 6

1. depreciation is based on original costs

2. financing costs is separate line in the calculation and it is subtracted out

Question 7

Economic profit

Answer 7

= NOPAT - $WACC
= EBIT(1-T) - $WACC
= EBIT(1-T) - (WACC*TotCapital)

Question 8

Market Value Added is the NPV based on economic profit

Answer 8

MVA = SUM[EPt/(1-WACC)^t]

Question 9

Residual Income

Answer 9

= Net Income - Equity Charge
= Net Income - Cost of Equity*Book Value @t-1
= NIt - Re*Bt-1
Then,
SUM[RIt/(1+Re)^t]

Question 10

Claims Valuations Approach focuses on dividing operating cash flows based on claims of debt and equity

Answer 10

CFdebt = [interest + principal]/(1+cost of debt)^t
CFequity = NI + depreciation - principal payments

Question 11

MM Proposition I (No Taxes)

Answer 11

The value of the firm is unaffected by its capital structure

Question 12

MM Proposition II (No Taxes)

Answer 12

The cost of equity increases linearly as a company increases it proportion of debt financing, because equity holders assume the added risk of debt..

Question 13

MM Proposition I (Taxes)

Answer 13

Value is maximized at 100 percent debt, due to the tax shield provided by debt.
Vl = Vu + (t*d)

Question 14

MM Proposition II (Taxes)

Answer 14

WACC is minimized at 100% Debt

Question 15

Static Trade-Off Theory

Answer 15

Balance the costs of financial distress with the tax shield benefit from debt
Vl = Vu + (t*d) - PV(cost of financial distress)

The optimal proportion of debt is achieved at the minimized WACC

Question 16

Dividend effective tax rate

Answer 16

= corporate tax rate + ( 1 - corporate tax rate)*(inidividual tax rate)

Question 17

Expected dividend

Answer 17

= previous dividend + [ expected increase in EPS * target payout ratio * adjustment factor]

Question 18

Stock repurchases decrease cash and stockholders’ equity, increasing leverage (i.e. D/E ratio)

Answer 18

EPS will likely increase as the # of shares decrease

Question 19

Dividend payout ratio

Answer 19

dividends / net income

Question 20

Dividend coverage ratio

Answer 20

net income / dividends

Question 21

FCFE coverage ratio

Answer 21

FCFE / (dividends + stock repurchases)

if ratio < 1 by much, it is considered unsustainable

Question 22

Bootstrapping

Answer 22

high P/E firm buys a low P/E firm in a stock transaction to lower its own P/E

Question 23

Herfindahl-Hirschman Index

Answer 23

SUM(MSi*100)^2
where,
MSi = Market Share of firm i

HHI <1000 - industry is competitive
1000

Question 24

Determining the Value of a target using free cash flows

Answer 24

1. Use a 2- or 3-stage model?
2. Develop proforma financial statements
3. Calculate Free Cash Flows
   Net Income
   + Net Interest After Tax
   = Unlevered Net Income
   + Change in Deferred Taxes
   = Net operating Profit after taxes (NOPAT)
   + Net Noncash Charges
   - WCinv
   -FCinv
   =Free Cash Flows
4. Discount Free CFs
5. Determine the Terminal Value at the present discount

Question 25

Post-Merger Value of an acquirer

Answer 25

Vat = Va + Vt + S - C
where,
Vat = post merger value of the combined company
Va= pre merger value of the acquirer
Vt = premerger value of the target
S = synergies 
C = cash paid to target shareholders

Question 26

Gains Accrued to Target

Answer 26

GainT = TP = Pt-Vt
where,
Pt = price paid for target
Vt = pre-merger value of target

Question 27

Gains accrued to the Acquirer

Answer 27

Gain = S - TP = S - (Pt-Vt)
where,
Pt = price paid for target
Vt = pre-merger value of target
S = synergies