Corporate Finance Flashcards
There are three incremental cash flows to be identified when evaluating a capital project:
- Initial Investment Outlay
- After Tax Cash Flows from Operations
- Terminal Year after-tax non operating cash flows
Initial Investment Outlay
= FCinv+WCinv
After-Tax Cash Flows from Operations
= (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
Terminal Year After-Tax Non-Operating CFs
TNOCF = SalT + WCinv - T(SalT - Bt)
where,
SalT = pretax cash proceeds from sale of fixed capital
Bt = book-value of the fixed capital sold
Economic Income
= cash-flows + (ending market value - beginning market value)
= cash flow - economic depreciation
Accounting Income differs from economic income by:
- depreciation is based on original costs
2. financing costs is separate line in the calculation and it is subtracted out
Economic profit
= NOPAT - $WACC
= EBIT(1-T) - $WACC
= EBIT(1-T) - (WACC*TotCapital)
Market Value Added is the NPV based on economic profit
MVA = SUM[EPt/(1-WACC)^t]
Residual Income
= Net Income - Equity Charge = Net Income - Cost of Equity*Book Value @t-1 = NIt - Re*Bt-1 Then, SUM[RIt/(1+Re)^t]
Claims Valuations Approach focuses on dividing operating cash flows based on claims of debt and equity
CFdebt = [interest + principal]/(1+cost of debt)^t CFequity = NI + depreciation - principal payments
MM Proposition I (No Taxes)
The value of the firm is unaffected by its capital structure
MM Proposition II (No Taxes)
The cost of equity increases linearly as a company increases it proportion of debt financing, because equity holders assume the added risk of debt..
MM Proposition I (Taxes)
Value is maximized at 100 percent debt, due to the tax shield provided by debt.
Vl = Vu + (t*d)
MM Proposition II (Taxes)
WACC is minimized at 100% Debt
Static Trade-Off Theory
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
Dividend effective tax rate
= corporate tax rate + ( 1 - corporate tax rate)*(inidividual tax rate)
Expected dividend
= previous dividend + [ expected increase in EPS * target payout ratio * adjustment factor]
Stock repurchases decrease cash and stockholders’ equity, increasing leverage (i.e. D/E ratio)
EPS will likely increase as the # of shares decrease
Dividend payout ratio
dividends / net income
Dividend coverage ratio
net income / dividends
FCFE coverage ratio
FCFE / (dividends + stock repurchases)
if ratio < 1 by much, it is considered unsustainable
Bootstrapping
high P/E firm buys a low P/E firm in a stock transaction to lower its own P/E
Herfindahl-Hirschman Index
SUM(MSi*100)^2
where,
MSi = Market Share of firm i
HHI <1000 - industry is competitive
1000
Determining the Value of a target using free cash flows
- Use a 2- or 3-stage model?
- Develop proforma financial statements
- 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 - Discount Free CFs
- Determine the Terminal Value at the present discount
Post-Merger Value of an acquirer
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
Gains Accrued to Target
GainT = TP = Pt-Vt
where,
Pt = price paid for target
Vt = pre-merger value of target
Gains accrued to the Acquirer
Gain = S - TP = S - (Pt-Vt) where, Pt = price paid for target Vt = pre-merger value of target S = synergies
