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CFA II > Corporate Finance > Flashcards

Corporate Finance Flashcards

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1
Q

When looking at optimal abandonment strategy, which two figures should be compared?

A

The PV of future cash flows at the time of the abandonment option vs. the lump sum.

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2
Q

What is the formula for economic income of a project?

A

Economic Income = After Tax CF + Change in MV (Where MV is the PV of CFs)

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3
Q

What is the formula for economic profit?

A

Economic Profit (EVA) = NOPAT (EBI) - $WACC

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4
Q

Are replacement projects mutually exclusive?

A

Yes.

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5
Q

What is the formula for initial outlay?

A

Initial Outlay = Cost + Change in Net Working Capital

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6
Q

What is the formula for replacement initial outlay?

A

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.

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7
Q

Will company assets be replaced as they wear out under the Common Multiple of Lives and/or Equivalent Annual Annuity methods?

A

Yes - both these are methods for projects with unequal lives and will use the chain replacement method.

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8
Q

Under a strong legal system, what will be the amount of debt and the length of maturity on debt?

A

Strong Legal System = Low Debt & Long Maturities

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9
Q

When there are few institutional investors, what will be the amount of debt and the length of maturity on debt?

A

Few Institutional Investors = High Leverage & Short Maturity Debt

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10
Q

When capital markets are illiquid, what will be the amount of debt and the length of maturity on debt?

A

Illiquid Capital Markets = High Leverage & Short Maturity Debt

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11
Q

When there are few analysts and auditors, what will be the amount of debt and the length of maturity on debt?

A

Few analysts and auditors = High Leverage & Short Maturity Debt

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12
Q

When there is a greater reliance on banking, what will be the amount of debt and the length of maturity on debt?

A

Reliance on Banking = High Debt & Short Maturity

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13
Q

When there are low dividend yields, what will be the amount of debt and the length of maturity on debt?

A

Low Div Yields = Low Debt & Long Maturities

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14
Q

When there is high GDP growth, what will be the amount of debt and the length of maturity on debt?

A

High GDP Growth = Low Debt & Long Maturities

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15
Q

What is the formula for change in share price on ex-date?

A

Price at ex-date = D x (1-Td) / (1-Tcg)

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16
Q

What is the effect of a dividend payment on shareholder wealth?

A

Total wealth does not change - it just transfers out of equity into cash.

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17
Q

Under the residual dividend model, does the firm still pay a dividend if earnings are not enough to cover it?

A

No.

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18
Q

What is the formula for Expected Dividend?

A

Expected Dividend = Expected Increase in EPS x Payout Target x 1/ n adjustment periods.

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19
Q

Is fair management compensation a core part of corporate finance?

A

No, it’s not relevant.

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20
Q

Are disclosures relating to ops and financial position a core part of corporate finance?

A

Yes.

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21
Q

Why is an investment in a biotech firm investing in risky projects a Principal-Agent Relationship issue?

A

Because the upside is huge and downside small for the manager.

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22
Q

Is the board of directors using corporate counsel good corporate governance?

A

No, because this is the firm’s internal counsel. A separate independent counsel should be used.

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23
Q

What is the main issue with having a CEO-Chairman?

A

The Chairman has a strong influence in setting the CEO salary.

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24
Q

Does a lack of good corporate governance affect the financial statements?

A

Yes - it increases the chance of a material misstatement.

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25
Q

Is a former employee on a board bad corporate governance?

A

Yes - they would not be classed as independent.

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26
Q

In M &A, what is a consolidation?

A

A new company is formed and the old ones cease to exist.

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27
Q

What is statutory consolidation?

A

Where the acquirer continues to exist but the target does not.

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28
Q

What typically happens to the stock prices of an acquirer and target after a merger announcement?

A

The target goes up 30% and the acquirer falls.

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29
Q

Is benchmarking one of the uses of equity valuation?

A

No.

30
Q

Which value should be used when considering an acquisition?

A

Investment value.

31
Q

Is the sum of parts value used to value the investments of a parent company.

A

No, it should be used to value the whole conglomerate.

32
Q

What is the formula for WACC?

A

WACC = (Equity Weight x k) + (Debt Weight x Cost of Debt)(1-T)

33
Q

What is the formula for Growth Relative to GDP?

A

Growth Relative to GDP = GDP x (1 + Revenue Growth)

34
Q

When looking at economies of scale, what is a better comparison - time series or large company vs. small company?

A

Large company vs. Small Company.

35
Q

What is the formula for Justified Leading P/E?

A

Justified Leading P/E = 1-b/ r-g (i.e. Annuity of payout ratio)

36
Q

How can you calculate price from Earnings, the risk-free rate, and PVGO?

A

P = (E/R) + PVGO

37
Q

How does a change in leverage affect FCFF?

A

Changes in leverage do not affect FCFF, as this is a pre-financing decision.

38
Q

How does issuing debt affect FCFE in early and later years?

A

FCFE increases in the first year and then is lower in subsequent years.

39
Q

How should unexpected gains on PPE be treated for purposes of calculating cash flow?

A

It should be removed.

40
Q

How can P/S be calculated if given profit margin, plowback ratio, g, and r

A

Price/Sales = Profit Margin x ((1-B) x (1+g)) / r-g

41
Q

How can Leading P/E be calculated if given Trailing P/E and g?

A

Leading P/E = Trailing P/E / 1+g

42
Q

What is Terminal Non-Operating Cash Flow (TNOCF) and how is it calculated?

A

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.

43
Q

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?

A

The cost of equity will increase linearly with the increase in proportion of debt.

44
Q

What is the static trade-off theory?

A

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.

45
Q

When there are favourable tax rates on dividends, what will be the amount of debt and the length of maturity on debt?

A

Low levels of debt and long maturities.

46
Q

What is the pecking order theory?

A

The pecking order theory is that financing is determined by the signal it will send to investors.

The pecking order is:

  1. Internal Capital
  2. Debt
  3. External Equity
47
Q

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
A
  1. Calculate amount needed to service equity (Target Equity % x Capital Budget).
  2. Subtract this amount from net income. The amount remaining is what can be paid out as dividends.
48
Q

If a question gives a cost of retained earnings and a cost of issuing new equity, which should you use for calculating WACC?

A

The cost of retained earnings, as this is internal capital, which is preferred under the pecking order theory.

49
Q

What does the Friedman Doctrine say?

A

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.

50
Q

What do Kantian ethics say?

A

People are different from factors of production; they are more than just an economic input and deserve dignity and respect.

51
Q

What do rights theories say?

A

All individuals have fundamental rights and privileges. The greatest good of utilitarianism cannot violate these rights.

52
Q

What do justice theories say?

A

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.

53
Q

What are the core objectives of effective corporate governance?

A
  1. Eliminate or reduce conflicts of interest.

2. Ensure company assets are used in a manner consistent with the interests of investors.

54
Q

How often should independent directors meet without management?

A

At least annually.

55
Q

Are family members on the board of directors a corporate governance issue?

A

Yes, they are not independent.

56
Q

Do board members need to be trained before serving?

A

Yes, this would be consistent with best practice.

57
Q

What is bootstrapping in an M&A context?

A

A high P/E firm acquiring a low P/E firm, which boosts EPS.

58
Q

What are the three thresholds for HHI, their concentration definitions, and the movement required to trigger antitrust action?

A

< 1000 - Not Concentrated - Any change is allowed

1000 - 1800 - Moderately Concentrated - Trigger is 100

> 1800 - Highly Concentrated - Trigger is 50

59
Q

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?

A

An equity carve-out.

60
Q

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

A spin-off.

61
Q

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

A split-off.

62
Q

Is a fair price amendment a pre-offer or post-offer defense?

A

A pre-offer defense.

63
Q

What is the effect of additional debt on the net agency costs of equity?

A

The net agency costs of equity are reduced because less capital is at risk.

64
Q

What is the formula for cash flow of a project?

A

CF = (Sales - Op Costs - Dep.)(1-T) + Dep

65
Q

What is the formula to de-lever a beta?

A

Unlevered Beta = Beta x (1/ 1 + D/E)

66
Q

Should cash flow projections include the impact of increased competition?

A

Yes.

67
Q

What is the formula for post-merger value of two companies?

A

Post-Merger Value = Pre-Merger Value A + Pre-Merger Value B + Synergies.

68
Q

In an equity carve out, does the parent company maintain any control.

A

Yes.

69
Q

What is the effect of using straight-line depreciation as opposed to accelerated depreciation on project NPV?

A

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.

70
Q

When an acquirer acquires a target with unused tax losses, when are these recognised?

A

Immediately.

71
Q

What is a bear hug?

A

In a hostile takeover, the offer is made straight to the board in an attempt to avoid management.

72
Q

What is a proxy fight?

A

When the acquirer tries to persuade shareholders to vote in a new merger-friendly board of directors.

CFA II (11 decks)

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