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CFA 2 > Corporate Finance > Flashcards

Corporate Finance Flashcards

1
Q

Cash Flow Equation given S, C, D =

Outlay =

Terminal Non Operating Cash Flow =

A

Cash Flow = (Sales - Operating Cost - Dep)(1-t) + Dep

Outlay = FCInv + NWCInv - Sale price + Tax x (Sale price - Book value)

TNOCF = Sale price + WCInv - (Tax (sale price - Book value))

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2
Q

Incremental operating cash flow =

Incremental Non-operating cash flow =

A

Incremental operating cash flow = Change Revenue - change operating costs - change depreciation x (1-t x change depreciation)

Incremental Non-operating cash flow = change salvage value + increase WC - Tax x ( Change salvage - change BV)

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3
Q

IRR cash flows =

NPV and IRR are the same for =

NPV preferred over IRR when =

A

IRR cash flows = cash flows are reinvested at the IRR

NPV and IRR give same decision for = Independent projects

NPV preferred over IRR when projects are mutually exclusive

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4
Q

China dividends paid:

Japan dividends paid:

A

China dividends paid: Annually

Japan dividends paid: Semi-annually

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5
Q

Economic Income =

Economic profit =

A

Economic Income = Cash flow - economic depreciation

Economic Income = cash flow + (ending mkt value - opening mkt value)

Economic profit = EBIT(1-t) - (WACC x Capital) = NOPAT - $WACC

NOPAT = EBIT(1-t)
$WACC = Capital x WACC
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6
Q

Residual Income =

Company Value =

Claims valuation approach =

A

Residual Income = NI - (r x BV Equity)

Company Value = PV of RI + Value of debt + Value of Equity

Claims valuation approach = NPV of debt payments + NPV of dividend payments

NPV of debt payments discounted at interest expense
NPV of dividend payments discounted at r

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7
Q

Modigliani Miller
MM1 without taxes

MM2 without taxes

MM1 with taxes

MM2 with taxes

A

MM1 without taxes = VLevered = V Unlevere, capital structure is irrelevant as equities and bonds trade perfectly competitve. Income is not related to capital structure

MM2 without taxes = Cost of equity increases linnearly as company increases its proportion of debt financing D/E. Beta increases with debt. Cost of debt is less than equity.

(without taxes WACC stays the same as D/E increases)

MM1 with taxes = company value is maximised at 100% debt

MM2 with taxes = WACC is minimized at 100% debt. i.e. increasing debt finance decreases the WACC.

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8
Q

Free cash flow hypothesis =

Pecking order theory =

A

Free cash flow hypothesis = Higher debt levels can force managers to manage a company more effectively.

Pecking order theory = Low information content preferred. “IDE”
Internally finance = low info and preferred
Debt = Middle
Equity = High information content least preferred

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9
Q

Static trade off theory =
- Higher tax rate:

Developed Countries with efficient legal system, equity or debt?

Developing countries with High inflation and high GDP growth equity or debt?

A

Static trade off theory = Seeks to balance cost of financial distress with tax shielf benefit. Higher tax rate = higher tax shield.

Developed = Equity is preferred within efficient legal systems. Long term debt would be preferred if GDP is stable in a mature country.

Developing = Equity is preferred if inflation is high and GDP is strong

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10
Q

Biggest yield changes from:

Moodys Investment grade down to Speculative grade =

S&P Investment grade to speculative grade =

A

Moodys = Baa to Ba

S&P = BBB to BB

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11
Q

More leverage from

Less leverage from

A

More leverage from low inflation markets

Less leverage from large institutional investor base with longer maturities. Equity preferred.

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12
Q

Stock dividend

vs

Cash dividend

A

Stock dividend receives shares rather than cash so is non-dilutive and does not affect leverage.

Cash dividend reduces assets and equity to increase d/e ratio. Reduced liquidity ratios.

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13
Q

Dividend Irrelevance theory =

Bird in the hand theory =

Clientele effect =

Dividend signaling =

A

Dividend Irrelevance theory = whether you issue new shares or pay dividends is irrelevant as they will exactly offset eachother. cost of equity and payout ratio remain unchanged

Bird in the hand theory = cash in the hand preferred so as payout ratio increases so too does stock price. High dividend payout is considered less risky.

Clientele effect = dividends are preferred by differing groups eg some investors prefer short term income. It tends to lead to stable dividend policies.

Dividend signaling = Dividend signaling acknowledges the existence of information asymmetry in that managers and directors have information not available to investors.

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14
Q

Dividend imputation system =

Split rate tax system =

Residual dividend policy =

A

Dividend imputation system is where shareholders receive a franking credit and investors are only taxed once on income

Split rate tax system is where corporate earnings can either be paid or retained. those PAID are taxed at a lower rate of corporate tax.

Residual dividend policy is where leftover positive NPV projects are paid in dividends.

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15
Q

Expected dividend equation =

Earnings Yield =

FCFE coverage ratio =

A

Expected dividend = Previous dividend + (Expected earnings x target payout ration - previous dividend) x 1/adjustment period

Earnings Yield = NI / market value of all shares

FCFE coverage ratio = FCFE / Dividends + share repurchases

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16
Q

Dividend payout ratio =

A

Common share cash dividend / NI = Dividend / EPS

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17
Q 
40% debt
60% equity
Net income 14m
capital budget 12m
dividend paid in cash?
A

12 x 0.6 = 7.2

14 - 7.2 = 6.8m for dividends

18
Q

Checking if a buyback from debt is worth it?
EPS is positive if
EPS is negative if

A

Check Earnings Yield vs cost of debt
EPS is positive if E/P > cost of debt = No earnings dilution
EPS is negative if E/P < cost of debt = EPS dilution will occur (cost of debt exceeds earnings yield)

19
Q

EPS after buyback =

A

EPS after = Total earnings - after tax cost of funds / shares outstanding after buyback

20
Q

Following a buyback

BVPS > Market price =

BVPS < Market price =

A

BVPS > Market price = Following buyback BVPS will increase

BVPS < Market price = Following buyback BVPS will decrease

21
Q

Buy Back techniques

Fixed price tender offer

Vs

Dutch Auction

If current price is $42

A

Fixed price tender offer = $44 (frowned upon to offer below this level)

Vs

Dutch Auction = $42 - $46 and will uncover a minimum price a company can buy back shares.

22
Q

Statutory Merger

Consolidation

Subsidiary Merger

A

Statutory Merger one company will cease to exist.

Consolidation companies form a new business and terminate legal existence of old brands.

Subsidiary Merger where purchased company becomes subsidiary.

23
Q

Horizontal Merger

Vertical Merger

Merger bootstrapping
- PE must be higher/lower to increase share price?

A

Horizontal Merger = Same industry company (usually competition) merges can help boost sales easier.

Vertical Merger = Merger with a supplier

Merger bootstrapping = Increasing EPS without economic gain. PE of acquirer must be higher to increase share price.

24
Q

Which companies prefer a horizontal merger?

Least preferred?

A

Stable growth to benefit from economies of scale.

Pioneering stage companies

Least preferred for young and growing companies.

25
Q

Stock purchase acquisition

Vs

Asset purchase acquisition

A

Stock purchase acquisition requires 50% approval and is most common.

Vs

Asset purchase acquisition is quicker as no stockholder approval is required. Does not assume all liabilities and shareholders dont pay CGT.

26
Q

Control premium =

A

Control premium = no shares x exchange ratio

Control premium = cost to acquire - pre-merger value

27
Q

Tender offer =

Poison pill =

Flip in pill =

Flip over pill =

Poison Put =

A

Tender offer = shareholders invited directly to sell shares to acquring company bypassing management.

Poison pill = Heavily diluting share price by selling cheaply to existing shareholders

Flip in pill = Target company shareholders buy their own shares. “Flip in to buy our own shares”

Flip over pill = Target company shareholders buy acquirers shares. “Flip over to buy acquirer”

Poison Put = A poison put is a takeover defense because it allows existing bond holders to redeem their bonds (usually) at a premium to par. This increases the cost of the takeover

28
Q

White knight defense

Pacman defense

Fair price amendment

Crown jewel defense

Greenmail defense

A

White knight defense where a non hostile partner will create a bid war driving up price making takeover less attractive

Pacman defense where a counter offer to buy the acquirer is made

Fair price amendment incase shares have dropped which makes an average price over a define period in which shares cannot be purchased below this price.

Crown jewel defense where takeover target decides to quickly sell a most profitable subsidiary to a neutral third party to amke the takeover less attractive.

Greenmail defense is where acquiree company can buy back own shares at a premium and acquirer cannot launch another hostile bid for a defined period.

29
Q

Herfindahl-Hirschman Index

Market concentration levels, what change levels creates an antitrust challenge
Not concentrated
Moderately concentrated
Highly concentrated

Post merger HHI equation

A

HH Market concentration levels

Not concentrated: < 1000
Moderately concentrated: between 1000 to 1800 (100 change creates anti trust challenge)
Highly concentrated: > 1800 (50 change creates antitrust challenged

Post merger HHI = (#1)^2 + (#2)^2 + (#3)^2 + (#4)^2 + (#5)^2 + (#6 + #7)^2 +… to 10 = 1310

30
Q

Post merger value =

Gain =

A

Post merger value = Pre-merger MV equity acquirer + Pre merger MV of Acquiree + economies of scale) - cash paid

Gain = Post merger value - pre merger value

31
Q

Bad merger signs

Average returns following merger

A

Bad mergers will have lots of bidders which drives up price to create a worse deal. ie high transaction premium.

Average returns following a merger have tended to be worse

32
Q

Horizontal ownership

Vertical ownership

One tier board

Two tier board

A

Horizontal ownership where owners have ‘cross holdings’ in one another

Vertical ownership where a ‘controlling interest’ owns operating companies

One tier board = Composed of non executive and executive directors

Two tier board = supervisory board oversees management board

33
Q

Dispersed ownership and dispersed voting power =

Concentrated ownership and concentrated voting power =

Dispersed ownership and concentrated voting power =

A

Dispersed ownership and dispersed voting power = weak share holders and a principal-agent problem (shareholders fall out with management)

Concentrated ownership and concentrated voting power = Strong shareholders and a principal-principal problem (shareholders fall out with shareholders)

Dispersed ownership and concentrated voting power = = Shareholders gain control thorugh pyramid structures which again creates principal-principal problems.

CONCENTRATED VOTING POWER CREATES Principal-principal issue

34
Q

Dual class share agreements

Who produces materiality maps?

A

Benefit one group usually managers more than others as they receive greater voting rights.

SASB - Sustainable Accounting Standards Board create materiality maps and aim to make ESG reporting more uniform. They are not for profit.

35
Q

ESG Factors =

Green bonds trade at premium or discount? What are they.

Who oversees Green bonds?

ESG mitigation of downside risk and enhance returns apply to:
Equity
Bonds

A

Often immaterial, voluntary, and inconsistent.

ESG Bonds often trade at a premium due to increased demand. They are used to fund ‘green’ projects.

Green bonds are overseen by ICMA - International Capital Markets Association.

Equities - Aim to mitigate downside risk and enhance returns
Bonds: Aim to mitigate downside risk only.

36
Q

Replacement chain method
.
3 year computer costs 3000 and 5% discount rate.

NPV in 6 years?

A

Use CF function and you need TWO computers

CF0 = -3000
CF1 = 1000
CF2 = 2000
CF3 = 2000 - 3000 (rebuy)
CF4 = 1000
CF5 = 2000
CF6 = 2000

I = 5%
CPT NPV = 2786

Compare this to a simple 6 year life machine.

37
Q

Abandonment Option

A

Step 1 - Weighted average Positive outcome plus negative outcome. 0.4 x 6 + 0.6 x 3.5 = 4.5 THEN CF0 -25m CF1 = 4.5 for ten years = 6.61

Step 2 - Positive outcome CF0 -25m CF1 6 for ten years = 17.14

Step 3 Negative outcome CF0 -25m CF1-2 3.5m CF3 = 3.5 PLUS 22m abandonmnet options = 2.14

0.4 x 17.14 + 0.6 x 2.14 = 8.14

Abandonment option = 8.14 - 6.61 = 1.53

38
Q

Backward integration vs Forward integration

A

Backward integration is companies before you in the supply chain. Forward integration would be bringing in a company ahead of you ie a sales outlet chain.

39
Q

Bootstrapping

A

Bootstrapping occurs when the company’s earnings increase as a result of a merger transaction as opposed to the result of the economic benefits of the merger. This is only possible if the shares of the acquirer trade at a higher P/E ratio than those of the target.

Acquiree PE must be LESS than Acquirer PE for bootstrapping to occur.

40
Q

Average price fall ex div % =

A

Av price fall ex div % = 1 - Tax rate dividend / 1 - Tax rate capital gain

CFA 2 (10 decks)

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