Corporate Finance Flashcards
Cash Flow Equation given S, C, D =
Outlay =
Terminal Non Operating Cash Flow =
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))
Incremental operating cash flow =
Incremental Non-operating cash flow =
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)
IRR cash flows =
NPV and IRR are the same for =
NPV preferred over IRR when =
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
China dividends paid:
Japan dividends paid:
China dividends paid: Annually
Japan dividends paid: Semi-annually
Economic Income =
Economic profit =
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
Residual Income =
Company Value =
Claims valuation approach =
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
Modigliani Miller
MM1 without taxes
MM2 without taxes
MM1 with taxes
MM2 with taxes
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.
Free cash flow hypothesis =
Pecking order theory =
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
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?
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
Biggest yield changes from:
Moodys Investment grade down to Speculative grade =
S&P Investment grade to speculative grade =
Moodys = Baa to Ba
S&P = BBB to BB
More leverage from
Less leverage from
More leverage from low inflation markets
Less leverage from large institutional investor base with longer maturities. Equity preferred.
Stock dividend
vs
Cash dividend
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.
Dividend Irrelevance theory =
Bird in the hand theory =
Clientele effect =
Dividend signaling =
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.
Dividend imputation system =
Split rate tax system =
Residual dividend policy =
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.
Expected dividend equation =
Earnings Yield =
FCFE coverage ratio =
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
Dividend payout ratio =
Common share cash dividend / NI = Dividend / EPS
40% debt 60% equity Net income 14m capital budget 12m dividend paid in cash?
12 x 0.6 = 7.2
14 - 7.2 = 6.8m for dividends
Checking if a buyback from debt is worth it?
EPS is positive if
EPS is negative if
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)
EPS after buyback =
EPS after = Total earnings - after tax cost of funds / shares outstanding after buyback
Following a buyback
BVPS > Market price =
BVPS < Market price =
BVPS > Market price = Following buyback BVPS will increase
BVPS < Market price = Following buyback BVPS will decrease
Buy Back techniques
Fixed price tender offer
Vs
Dutch Auction
If current price is $42
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.
Statutory Merger
Consolidation
Subsidiary Merger
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.
Horizontal Merger
Vertical Merger
Merger bootstrapping
- PE must be higher/lower to increase share price?
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.
Which companies prefer a horizontal merger?
Least preferred?
Stable growth to benefit from economies of scale.
Pioneering stage companies
Least preferred for young and growing companies.
Stock purchase acquisition
Vs
Asset purchase acquisition
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.
Control premium =
Control premium = no shares x exchange ratio
Control premium = cost to acquire - pre-merger value
Tender offer =
Poison pill =
Flip in pill =
Flip over pill =
Poison Put =
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
White knight defense
Pacman defense
Fair price amendment
Crown jewel defense
Greenmail defense
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.
Herfindahl-Hirschman Index
Market concentration levels, what change levels creates an antitrust challenge
Not concentrated
Moderately concentrated
Highly concentrated
Post merger HHI equation
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
Post merger value =
Gain =
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
Bad merger signs
Average returns following merger
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
Horizontal ownership
Vertical ownership
One tier board
Two tier board
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
Dispersed ownership and dispersed voting power =
Concentrated ownership and concentrated voting power =
Dispersed ownership and concentrated voting power =
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
Dual class share agreements
Who produces materiality maps?
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.
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
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.
Replacement chain method
.
3 year computer costs 3000 and 5% discount rate.
NPV in 6 years?
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.
Abandonment Option
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
Backward integration vs Forward integration
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.
Bootstrapping
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.
Average price fall ex div % =
Av price fall ex div % = 1 - Tax rate dividend / 1 - Tax rate capital gain
