Corporate Finance Flashcards
When looking at optimal abandonment strategy, which two figures should be compared?
The PV of future cash flows at the time of the abandonment option vs. the lump sum.
What is the formula for economic income of a project?
Economic Income = After Tax CF + Change in MV (Where MV is the PV of CFs)
What is the formula for economic profit?
Economic Profit (EVA) = NOPAT (EBI) - $WACC
Are replacement projects mutually exclusive?
Yes.
What is the formula for initial outlay?
Initial Outlay = Cost + Change in Net Working Capital
What is the formula for replacement initial outlay?
Replacement Initial Outlay = FCInv + NWCInv - Sale + T(Sale-Book)
i.e. The costs of the new project plus the after-tax profit on the sale.
Will company assets be replaced as they wear out under the Common Multiple of Lives and/or Equivalent Annual Annuity methods?
Yes - both these are methods for projects with unequal lives and will use the chain replacement method.
Under a strong legal system, what will be the amount of debt and the length of maturity on debt?
Strong Legal System = Low Debt & Long Maturities
When there are few institutional investors, what will be the amount of debt and the length of maturity on debt?
Few Institutional Investors = High Leverage & Short Maturity Debt
When capital markets are illiquid, what will be the amount of debt and the length of maturity on debt?
Illiquid Capital Markets = High Leverage & Short Maturity Debt
When there are few analysts and auditors, what will be the amount of debt and the length of maturity on debt?
Few analysts and auditors = High Leverage & Short Maturity Debt
When there is a greater reliance on banking, what will be the amount of debt and the length of maturity on debt?
Reliance on Banking = High Debt & Short Maturity
When there are low dividend yields, what will be the amount of debt and the length of maturity on debt?
Low Div Yields = Low Debt & Long Maturities
When there is high GDP growth, what will be the amount of debt and the length of maturity on debt?
High GDP Growth = Low Debt & Long Maturities
What is the formula for change in share price on ex-date?
Price at ex-date = D x (1-Td) / (1-Tcg)
What is the effect of a dividend payment on shareholder wealth?
Total wealth does not change - it just transfers out of equity into cash.
Under the residual dividend model, does the firm still pay a dividend if earnings are not enough to cover it?
No.
What is the formula for Expected Dividend?
Expected Dividend = Expected Increase in EPS x Payout Target x 1/ n adjustment periods.
Is fair management compensation a core part of corporate finance?
No, it’s not relevant.
Are disclosures relating to ops and financial position a core part of corporate finance?
Yes.
Why is an investment in a biotech firm investing in risky projects a Principal-Agent Relationship issue?
Because the upside is huge and downside small for the manager.
Is the board of directors using corporate counsel good corporate governance?
No, because this is the firm’s internal counsel. A separate independent counsel should be used.
What is the main issue with having a CEO-Chairman?
The Chairman has a strong influence in setting the CEO salary.
Does a lack of good corporate governance affect the financial statements?
Yes - it increases the chance of a material misstatement.
Is a former employee on a board bad corporate governance?
Yes - they would not be classed as independent.
In M &A, what is a consolidation?
A new company is formed and the old ones cease to exist.
What is statutory consolidation?
Where the acquirer continues to exist but the target does not.
What typically happens to the stock prices of an acquirer and target after a merger announcement?
The target goes up 30% and the acquirer falls.
Is benchmarking one of the uses of equity valuation?
No.
Which value should be used when considering an acquisition?
Investment value.
Is the sum of parts value used to value the investments of a parent company.
No, it should be used to value the whole conglomerate.
What is the formula for WACC?
WACC = (Equity Weight x k) + (Debt Weight x Cost of Debt)(1-T)
What is the formula for Growth Relative to GDP?
Growth Relative to GDP = GDP x (1 + Revenue Growth)
When looking at economies of scale, what is a better comparison - time series or large company vs. small company?
Large company vs. Small Company.
What is the formula for Justified Leading P/E?
Justified Leading P/E = 1-b/ r-g (i.e. Annuity of payout ratio)
How can you calculate price from Earnings, the risk-free rate, and PVGO?
P = (E/R) + PVGO
How does a change in leverage affect FCFF?
Changes in leverage do not affect FCFF, as this is a pre-financing decision.
How does issuing debt affect FCFE in early and later years?
FCFE increases in the first year and then is lower in subsequent years.
How should unexpected gains on PPE be treated for purposes of calculating cash flow?
It should be removed.
How can P/S be calculated if given profit margin, plowback ratio, g, and r
Price/Sales = Profit Margin x ((1-B) x (1+g)) / r-g
How can Leading P/E be calculated if given Trailing P/E and g?
Leading P/E = Trailing P/E / 1+g
What is Terminal Non-Operating Cash Flow (TNOCF) and how is it calculated?
TNOCF is cash flow that will be received at the end of the project.
TNOCF = Sal - T(Sal-BV) + NWC
i.e. The recovery of net working capital plus the after tax profit on the sale.
Under MM’s propositions, in a world with no tax, what will the effect of an increase in proportion of debt financing have on the cost of equity?
The cost of equity will increase linearly with the increase in proportion of debt.
What is the static trade-off theory?
The static trade-off theory is that the financial stress of debt financing needs to be balanced, and therefore 50% debt, 50% equity financing is the optimal capital structure.
When there are favourable tax rates on dividends, what will be the amount of debt and the length of maturity on debt?
Low levels of debt and long maturities.
What is the pecking order theory?
The pecking order theory is that financing is determined by the signal it will send to investors.
The pecking order is:
- Internal Capital
- Debt
- External Equity
Under a residual dividend policy, how do you calculate the amount to be paid out as dividends, given the following info:
- Capital Budget
- Capital Structure
- Net Income
- Calculate amount needed to service equity (Target Equity % x Capital Budget).
- Subtract this amount from net income. The amount remaining is what can be paid out as dividends.
If a question gives a cost of retained earnings and a cost of issuing new equity, which should you use for calculating WACC?
The cost of retained earnings, as this is internal capital, which is preferred under the pecking order theory.
What does the Friedman Doctrine say?
The only social responsibility of business is to increase profits within the rules of the game, through open and fair competition without deception and fraud.
What do Kantian ethics say?
People are different from factors of production; they are more than just an economic input and deserve dignity and respect.
What do rights theories say?
All individuals have fundamental rights and privileges. The greatest good of utilitarianism cannot violate these rights.
What do justice theories say?
Justice is met if all participants would agree the rules are fair if the results would be acceptable when decided under a veil of ignorance, i.e. If people didn’t know beforehand which part they were going to play.
What are the core objectives of effective corporate governance?
- Eliminate or reduce conflicts of interest.
2. Ensure company assets are used in a manner consistent with the interests of investors.
How often should independent directors meet without management?
At least annually.
Are family members on the board of directors a corporate governance issue?
Yes, they are not independent.
Do board members need to be trained before serving?
Yes, this would be consistent with best practice.
What is bootstrapping in an M&A context?
A high P/E firm acquiring a low P/E firm, which boosts EPS.
What are the three thresholds for HHI, their concentration definitions, and the movement required to trigger antitrust action?
< 1000 - Not Concentrated - Any change is allowed
1000 - 1800 - Moderately Concentrated - Trigger is 100
> 1800 - Highly Concentrated - Trigger is 50
If part of a company is separated to create a new independent company which will issue new stock to the public, what kind of divestment is this?
An equity carve-out.
If part of a company is separated to create a new independent company which existing shareholders will automatically get shares in, what kind of divestment is this?
A spin-off.
If part of a company is separated to create a new independent company which existing shareholders can exchange existing shares for, what kind of divestment is this?
A split-off.
Is a fair price amendment a pre-offer or post-offer defense?
A pre-offer defense.
What is the effect of additional debt on the net agency costs of equity?
The net agency costs of equity are reduced because less capital is at risk.
What is the formula for cash flow of a project?
CF = (Sales - Op Costs - Dep.)(1-T) + Dep
What is the formula to de-lever a beta?
Unlevered Beta = Beta x (1/ 1 + D/E)
Should cash flow projections include the impact of increased competition?
Yes.
What is the formula for post-merger value of two companies?
Post-Merger Value = Pre-Merger Value A + Pre-Merger Value B + Synergies.
In an equity carve out, does the parent company maintain any control.
Yes.
What is the effect of using straight-line depreciation as opposed to accelerated depreciation on project NPV?
Under accelerated depreciation the higher weighted early cash flows are higher as the depreciation tax shield is higher.
Therefore, NPV is lower under the straight line method.
When an acquirer acquires a target with unused tax losses, when are these recognised?
Immediately.
What is a bear hug?
In a hostile takeover, the offer is made straight to the board in an attempt to avoid management.
What is a proxy fight?
When the acquirer tries to persuade shareholders to vote in a new merger-friendly board of directors.
