Corporate issuers Flashcards
What is sole proprietorship?
Business owned and operated by individual, unlimited liability, only clain to net profits
What is business structure?
How business is set up from legal and organizational point of view
What is general partnership?
Two or more owners, unlimited liability, profits are distributed and taxed as personal income
What is partnership agreement?
It specifies reponsibilities and share of profit
What is limited partnership?
It has two levels: general and limited partners
What are general partners?
Owners with unlimited liability
What are limited partners?
They are liable for the amount they invest only and have claims proportionate to their investments
What is corporation?
It is legal entity separate from owners and managers, where all shareholders have limited liability. They may distribute profits and have greater access to capital
What is role of investor in corporation?
They do not directly influence day to day operations, but appoints BoD
What are non profit organizations?
They produce social benfit aor charitable goal, must reinvest all of the profits
What does double taxation mean?
It taxes profits and dividends
What is private placement memorandum (PPR)?
It gives information and risks on the company
How about time horizon lenght and return from private companies?
Longer horizon and higher return than for public companies
What is direct listing?
Stock exchange agrees to list existing shares
Does no listing raise new capital?
No
What is special purpose aquisition company (SPAC)?
It is corporate structure set up to aquire a private company in the future. It raises capital through IPO and puts the funds into trust it must use for acquisitions within specified period of time
What is leveraged buyout?
Outside investors buy all companie’s outstanding shares and revenue in stock exchange listing, if its management buyout (company mangers do so).
What are debt holders?
They have legal and contractual claim to the interest and principle payments the company promised to make
What are equity holders?
Thet have residual claim to the net assets and has unlimited upside potential
What is shareholder theory?
Primary focus is to governance interest of firms shareholders which is maximisation of the market value of firms common equity
What is interest of shareholders?
Residual interest in the corporation, have voting rights which give them effective control of the firm and the management
What is interest of BoD?
It is responsibility to protect interests of shareholders, manage senior management, set strategic direction and monitor financial performance
What is one-tier board?
Executive and non-executive members serve on single board
What is two-tier board?
Non-executive oversees management of executive
What is interest of senior managers?
To receive compensation + bonus + perqusities. Interest can include continued employment and maximising their compensation
What is interest of employees?
Interest in sustainability and success of the firm, their rate of pay, opportunity for career development, training and working conditions
What is interest of creditors?
Interest are protected by covenants and debt agreements
What is interest of suppliers?
Interest in ongoing relationship, profitability of trade and ongoing stability
What is principle-agent problem?
Agent is hired to act in the interest of principle, but agent’s interest might conflict with that of principle
Shareholders/managers conflict
Managers might choose lower level of risk as their performance depends on it
Groups of shareholders conflict
Int he aquisition majority sharehoder might have better terms than minority and might force to enter into related party transactions that benefit entities in expense of minority shareholder
Creditors/shareholders conflict
Shareholders prefer more risk because of unlmited upside potential, also risk can be increased by issuing more debt or paying dividends
What is corporate governance?
It is system of internal controls and procedures by which individual companies are managed to minimie conflict between internal and external shareholders
What is vote of proxy?
It is ability to assign a voting right to those who attend AGM if you are not able to participate
What is super resolutions?
It requires supermajority vote, 2/3 or 3/4 of the votes and is usually required in the extraordinary shareholders meeting
What is majority voting?
Candidates with most votes is elected, one is voted from in single category
What is cumulative voting?
Shareholders can cast all of their votes for a single candidate or divide among board members
Which voting represents minority interest?
Cumulative voting
What is activist shareholder?
It pressures companies for change that believe will increase shareholder value
What is proxy fight?
It seeks proxies of shareholders to vote in power of their alternative proposals
What is hostile takeover?
It is attempt to gain control over target company by sidestepping their management and BoD
What is bond indenture?
It is rights of bondholders and companys obligation, can include covenants
What does is mean to be backed by collateral?
Bond holders will have a claim over this asset in case the bond fails
What are creditors committees?
It is protection of bondholder interest in the times of financial distress
What is role of audit commitee?
Everything accounting, reporting and audit related
What is role of governance commitee?
Governance and regulations related
What is role of nominations commitee?
Everything related to elections of BoD
What is role of remuneration commitee?
Everything compensation to directors and senior managers, benefits for employees and evaluation of senior managers
What is role of risk commitee?
Everything risk policy and tolerance related
What is role of investment commitee?
Everything related to aquisitions, CAPEX and disposals
Which comittee is usually required by law?
Audit committee
What are employee, customers and suppliers mechanism?
Labor laws, employment contracts and rights to form unions, contracts
What are government mechanisms?
Is to establish agencies to regulate industries
What is common law system?
It is when judges ruling becomes law in some instances
What is civil law system?
It is when judges are bound on specifically enacted laws
What is responsible investing?
Considering ESG factors in investment decision
What is sustainable investing?
it is inveting in companies on industries based on their perceived sustainable output
What is socially responsible investing?
Choosing investment based on moral and social norms
What is negative screening?
It is excluding companies and industries based on their practices regarding human rights, environmental concerns or corruption
What is full integration?
Inclusion of ESG factors/scores in the traditional fundamental analysis
What is thematic investing?
Inveting in sectors/companies to promote ESG related goals
What is engagement/active ownership?
It is using ownership as a platforms to promote improved ESG practices
What is green finance?
It is producing economic growth in more sustainable way by reducing emissions and better resource management
What are green bonds?
Bonds for which resources raised are used for projects with positive environmental impact
What is business model?
How company proposes to make money
What does business model should include? (5)
Potential customers, product and service description, how firm will sell products, describe key assets and suppliers, explain pricing strategy
What is channel strategy?
How products will be sold and delivered
What is omnichannel strategy?
Firm usage of both digital and physical channels
What is value-based pricing?
Setting prices based on value perceived
What is cost based pricing?
Setting prices based on costs of producing + profit
What is price discrimination?
Changing different prices to different customers
What is tiered pricing?
It is based on volume of purchase
What is dynamic pricing?
It depends on tiering to a day or a week
What is bundling?
Pricing complementary products
What is razor-and-blades pricing?
Price of equipment at low prices and make profits by selling consumable goods
What is option pricing?
Options and add-ons with high margins are added after the purchase decision been made
What is penetration pricing?
Low margins or free to grow market and achieve sale of operations
What is freemium pricing?
Offer product at basic functionality at no cost, but sell/unlock other functionality for a fee
What is hidden revenue?
Online content might be free, but generate revenues through ads
What is fractional ownership?
Time share companies sell condominium ownership by the week
What is franchising?
It permits to sell in a specified area and pay % of sales to the franchiser
What is value proposition?
How customers will value the characteristics of the product giving competing products and pricing
What is value chain?
It is execution of value proposition
What is private label manufacturer?
Produce products for others to market under their own brand name
What is licencing agreements?
A brand is used on another product for a fee
What are value-added resellers?
Offer services as support, installation etc.
What is affiliate marketing?
Another company is paid commision for measurable marketing
What is marketplace?
Provide platform but do not own the products
What are aggregators?
Provide marketplace but you sell products and services under own brand name
What are network effects?
Increase in the value of a network as its user base grows
What is crowdsurfing?
It benefits from user contribution
What are hybrid business models?
It is platform and traditional sales models
What are external factors affecting risk? (3)
Changes in economic condition, changing in demographics, political, legal and regulatory changes
What is macro risk?
It is risk arising from economic, political and legal risk factors, as well as other risks that affect all businesses within region or country
What is competitive risk?
It is erosion of existing competitive advantage over time or introduction of innovative business models that disrupt the industry
What is product market risk?
Expectations for growth in demand might decrease
What is capital investment risk?
Investing firm assets in opportunities that do not provide returns above firm’s cost of capital
What are ESG risk?
Focus on corporate governance risk, but the risk of running afront of current expectations can damage reputation
What is operating leverage?
Fixed amount of the costs
What are business maintanance investments?
Going concern projects and regulatory/compliance projects
What are going concern projects?
They are needed to maintain business and reduce costs
What are regulatory/compliance projects?
They might be required anf often include safety related and environmental concerns
What are business growth projects?
They include expansion projects and other that include size and scope of the company
What is capital allocation process?
Identifying and evaluating capital projects
What is process of capital allocation process? (5)
Idea generation, analysing project proposals, creating firm-wide capital budget, monitoring decision and conducting post audit
What are sunk costs?
Cost that cannot be avoided regardless if the project is taken or not
What are principles of capital allocation? (5)
Decisions are based on incremental cashflows, CF are are based on opportunity costs, timing of CF is important, CF are analyzed on aftertax basis, financing costs are reflected in required rate of return
What are externalities?
Effects of project acceptance may have on other firms cash flows
What is cannibalization?
New project takes sales from an existing project
What is conventional CF pattern?
If the sign on the CF changes only once
What is unconventional CF pattern?
More than one sign change
What are independent projects?
Projects that can be evaluated solely on their own profitability
What are mutually exclusive projects?
Only one project can be accepted so profitability must be evaluated among projects
Formula of NPV
CF0+sum of CF/(1+k)^t
What is NPV rule?
If projects are independent, accept projects with positive NPV
What is IRR?
Discount rate that makes PV just equal to initial cost of the project
What is IRR rule?
If IRR>required rate of return, then accept the project
What is hurdle rate?
Minimum IRR required
What is key advantage of NPV?
Direct measure and best methods
What is flaw of NPV?
It does not take into account size of the project
What is key advantage of IRR?
It measures profitability as %, showing return and provides information on margin of safety
What is disadvantage of IRR?
It may produce different rankings of mutually exclusive projects and possibility that products have multiple IRRs
How to measure whether value for investors is created?
Compare return of company’s investment to cost of capital
Formula of ROIC
after-tax net profit/average book value of total capital
or
net operating profit after tax/average book value of total capital
Formula of after tax net profit
net income+after tax interest expense
Formula of net operating profit after tax
Subtract after-tax nonoperating income
When management is creating value for a firm?
ROIC>WACC
What is effect of NPV on stock price?
Proportional increase in the stock price
What are real options?
Future actions firm can take given they invest in project today, cannot be negative
What are timing options?
Allow a company to delay making investment as more information will be available in the future
What are abandoment options?
Abandon a project if PV of CF from exiting project exceeds the PV of CF for continuing the project
What are expansion options?
Allows to make additional investments in the future
What are flexibility options?
Gives managers choice regarding operational aspect
What are two flexibility options?
Price setting and production
What are fundamental options?
Projects that are options themselves because payoffs depend on the price of the underlying asset
Formula of operating cash flow
Net income+D&A-dividends
What is account receivable?
Amounts owed to a company from customers sales it makes on credit
Interpretation of 2/15 net 45
2% discount if paid within 15 days, if not, then have to pay in full in 45 days timeframe
What are marketable securities?
Liquid debt that company intends to sell within a year
What is uncommitted line of credit?
Bank extends an offer of credit for a certain amount but may refuse to lend if circumstances change
What is committed line of credit?
Bank extends an offer of credit that it commits to for some period of time
What is revolving line of credit?
Usually for longer terms, company’s can borrow and repay funds as their needs change
What is blank lien?
Claim to all current and future firms assets as collateral in case primary collateral is insufficient
What is factoring?
Sale of receivable at a discount from their face value
What is commercial paper?
Short-term debt security, up to one year, issued by companies with lower credit rating
What is conservative working capital management?
Current assets higher as % of sales
What is aggressive WC management?
Current assets lower as % of sales
What is primary source of liquidity?
Sources of cash it uses in its normal day-to-day operations
What is secondary source of liquidity?
Liquidating short-term or long-lived assets, renegotiating debt or filing for bankruptcy and reorganizing the company
What are drags on liquidity?
Delay or reduce cash inflows or increase borrowing costs
What are pulls on liquidity?
Accelerated cash outflows
What is formula of WACC?
wd * (kd(1-t))+wps * kps+wce * kce
What is after tax cost of debt?
Interest rate at which firms can issue new debt
What to use for cost of debt?
YTM of new debt, it not available then for current debt
Formula for cost of preffered stock
Dps/P
What is cost of equity?
Required rate of return on firm’s common stock
Formula of CAPM
rf+B(E(rmkt)-rf)
Formula of other way of determining cost of capital
bond yield+risk premium
Formula of adjusted B
2/3unadjusted beta+1/3
Why individual B varies?
Due to financial leverage and tax rates
What is formula of asset beta?
Bequity *(1/(1+[(1-t) * D/E]))
Formula for company’s Beta
Basset(1+[(1-t)*D/E])
What to do with groups B?
Take average
What are floating costs?
Fees charged by IB when company raises external capital
How to incorporate floating costs?
By adjusting selling price
What is the best method to incorporate floating costs?
As cash outflow in NPV model
What is optimal capital structure?
The one which minimizes WACC
What industry characteristics allows to make on more debt? (3)
Non-cyclical, low fixed operating costs, subscription based
What is debt capacity?
Extent to which it can finance itself with debt without risking insolvency
What is tax rate effect on value of a company?
Higher tax rates gives higher tax shield hence increases value of a leveraged company
How credit spreads move with business cycles?
They are narrow during expansions and widen during contractions
What are stages of company life cycle?
Start-up, growth stage and mature stage
What is start-up stage?
Risk is high, debt is risky requiring higher interest rate, hence mostly financed by equity
What is growth stage?
Risk is somewhat reduced, up to 20% might include debt
What is mature stage?
Debt might be in excess of 20% of firm’s capital structure
What is MM assumption I?
Capital structure is irrelevant for firms value
What are assumptions of MM (I)?
(5)
Capital markets are perfectly competitive, investors have homogenous expectations, riskless borrowing and lending, no agency costs, investment decisions are unaffected by financing decisions
What is MM assumption II?
As companies increase proportion of debt financing, the risk of CF to equity holders increases, which increases cost of equity, WACC and cost of debt does not change
MM formula of cost of equity
r0+D/E(r0-rd), where r0 is cost of equity with no debt
What is MM assumption III?
Optimal capital structure with taxes is 100%, as proportion of debt increases, WACC decreases
MM formula for leveraged firms value
leveraged firm’s value = unlevered firm + tax shield
MM formula of cost of equity with taxes
r0+D/E(r0-rd)(1-t)
What are costs of financial distress?
Increased costs a company faces when earnings decline to the point where the firm has trouble paying its fixed financing costs
What is probability of financial distress?
Firm’s use of operating and financial leverage
What is state (trade-off theory)?
Costs of financial distress balances with the tax shield benefits from using debt
Formula of leveraged company under trade-off theory
Vu+t*d-PV(costs of financial distress)
What is effect of asymmetric information on cost of debt and equity
Direct relationship
What are monitoring costs?
Expenses of reporting to shareholders and paying BoD
What are bonding costs?
Assuring managers are working the shareholder’s best interest
What is pecking order theory?
Signals management send to investors through its financing choices
What is funding preference from most to least?
Internally generated capital -> debt -> external equity
Whats is cost leverage?
Amount of fixed costs firm has
What is sales risk?
Uncertainty about the sales
What is operating risk?
Uncertainty about operating earnings caused operating costs
What is financial risk?
Additional risk that firm’s common stockholders must bear when firm has fixed costs financing
What is degree of operating leverage (DOL)?
% change in EBIT that results from given percentage change in sales, highest at low levels of sales
Formula of degree of operating leverage (DOL)
change in EBIT/change in sales
Q(P-V)/Q(P-V)-F or S-TVC/S-TVC-F
What is degree of financial leverage (DFL)
% change in net income/EPS to change in EBIT
Formula of degree of financial leverage (DFL)
change in EPS/change in EBIT
EBIT/EBIT-interest or S-TVC/S-TVC-I
What is degree of total leverage (DTL)
Combined degree of DOL and DFL
Formula of degree of total leverage (DTL)
DOL*DFL
Q(P-V)/Q(P-V)-F-I or S-TVC/S-TVC-F-I
What is relationship between financial leverage and ROE?
Direct
What is break even quantity of sales?
Quantity of sales for which revenue=total costs
What is contribution margin?
It is difference between price and variable costs per unit
Formula for break-even quantity of sales
fixed operating+fixed financing costs/price-variable costs per unit
What is operating break even quantity of sales formula?
fixed operating costs/price-variable cost per unit
What is relationship between fixed costs and break even quantity?
Direct
