Corporate Issuers

Question 1

Key features of organisational forms of business

Answer 1

1) Separate legal entity or not?
2) Do owners operate the business or not?
3) Is owner liability limited or unlimited?
4) What is the tax treatment of profits and losses?
5) Access to capital to fund expansion and distribute risk

Question 2

Sole proprietorship

Answer 2

Business owned and operated by an individual. Owner has unlimited liability. Profits get taxed as personal income. Small scale and access to external capital.

Question 3

General partnership

Answer 3

A partnership between multiple individuals whose business relationship is regulated by a partnership agreement. Everything else is the same as sole proprietorship.

Question 4

Limited partnership

Answer 4

Involves two level of partners - General and limited partners. Limited partners are liable only for the amount of their investment, and they have claims to profits proportional to their investment.

Question 5

Limited liability partnership (LLP)

Answer 5

All partners have limited partnership. Allowed in certain jurisdictions. In the USA, they are only allowed for providers of professional services such as lawyers, accountants etc.

Question 6

Corporation or limited company

Answer 6

It is a legal entity separate from its owners and managers. All shareholders have limited liability. The business may but is not required to distribute profits via dividends. Greater access to capital is possible. Its owners may be subject to double taxation.

Question 7

Public corporation (or public limited company)

Answer 7

A company which has shares that are sold to the public and trade in an organised market.

Question 8

Private limited company

Answer 8

Similar to a public corporation, but it has a limited number of shareholders and restrictions on transfers of shares. Known as LLC.

Question 9

Articles of incorporation

Answer 9

A document filed with a regulatory body which forms a corporation as a legal entity separate from its owners.

Question 10

Free float

Answer 10

Shares of a company that are available for active trading, i.e. they are not held by insiders, strategic investors or sponsors. Generally expressed as a percentage of the total shares outstanding.

Question 11

Private placements

Answer 11

A method private companies use to raise equity through private placement of securities. They are typically restricted to accredited investors such as corporate and institutional investors.

Question 12

Direct listing

Answer 12

An operation which includes a stock exchange agreeing to list a private company’s existing shares. one method of a private company going pub

Question 13

Methods of a private company to go public

Answer 13

1) Initial public offering
2) Direct listing
3) Special Purpose Acquisition Vehicle

Question 14

Special Purpose Acquisition Vehicle (SPAC)

Answer 14

Corporate structure set up to acquire a private company in the future. It raises capital through an IPO and puts the funds into a trust that it must use the make an acquisition within a specified period of time. The acquired company needs not be identified at the time of the IPO.

Question 15

Value of a company

Answer 15

Sum of the market value of the company’s debt and equity instruments.

Question 16

Shareholder theory

Answer 16

A theory of corporate governance which is primarily concerned with the conflict of interest between the firm’s managers and owners. Shareholder interest of maximising the value of their equity is seen as paramount.

Question 17

Stakeholder theory

Answer 17

A theory of corporate governance which considers conflicts among several groups that have an interest in the activities and performance of the firm.

Question 18

List the stakeholders of the corporation?

Answer 18

1) Owners
2) Lenders
3) Senior managers
4) Employees
5) Suppliers
6) Customers
7) Governments

Question 19

Negative externalities

Answer 19

A phenomenon which is defined as an economic agent not bearing the full cost of their actions, i.e. some of its costs are imposed unwillingly to other agents.

Question 20

Why are stakeholders interested in ESG evaluation?

Answer 20

1) Governments are increasingly prioritising environment standards compliance
2) ESG factors can have a material impact on companies’s results
3) Many younger investors are allocating capital based on these considerations

Question 21

Physical risk (environmental)

Answer 21

Risk of adverse effects on assets or operations if severe weather increases in frequency.

Question 22

Transition risk (environmental)

Answer 22

Risk of regulations and customer choice requiring switching to low-carbon activities.

Question 23

Stranded assets

Answer 23

Assets that become unviable due to the listed environmental risks.

Question 24

A company’s social factors

Answer 24

Factors that include the measurement of quality of customer privacy and information security, customer satisfaction, employee engagement, diversity and inclusion, labor relations, and community relations.

Question 25

A company's governance factors

Answer 25

Factors that include the measurement of quality of board composition, composition of the internal audit committee, executive compensation, bribery, corruption, political contributions and lobbying.

Question 26

Principal-agent relationship

Answer 26

A relationship between multiple entities where one group of entities has to carry out a task (agents) on behalf of the other group (principals).

Question 27

Agency costs

Answer 27

Costs arising from the principal-agent relationship.

Question 28

Dual class structure of equity

Answer 28

Equity distribution in which there exist classes of common stock outstanding, some with more voting power than others.

Question 29

Corporate governance

Answer 29

The system of internal controls and procedures by which individual companies are managed.

Question 30

Stakeholder management

Answer 30

Refers to the management of company relations with stakeholders. It is based on having a good understanding of stakeholder interests and maintaining effective communication with stakeholders.

Question 31

Annual general meeting

Answer 31

Meeting where company management provides shareholders with the audited financial statements for the year, addresses the company's performance and significant actions over the period, and answers shareholder questions.

Question 32

Vote by proxy

Answer 32

A shareholder assigns the rights of vote at the general meeting to another person who will attend the meeting.

Question 33

Activist shareholders

Answer 33

Shareholders which hold a significant number of shares and which pressure the company to enact changes they believe will increase shareholder value.

Question 34

Proxy contest

Answer 34

An initiative by an activist shareholder in which they seek the proxies of shareholders to vote in favor of their alternative proposals.

Question 35

Hostile takeover

Answer 35

A takeover attempt not supported by a company's current management.

Question 36

Bond indenture

Answer 36

A legal document which specifies the rights of bondholders and the company's obligations.

Question 37

Covenants

Answer 37

Clauses in the bond indenture which require the company to take certain actions or to place restrictions on certain actions.

Question 38

Creditor committee

Answer 38

A committee of bondholders formed to protect their interests when an issuer experiences financial distress.

Question 39

Board of directors

Answer 39

A corporate body elected by shareholders to act on their behalf and guard their interests in the corporation. It elects company management, sets strategic course of the company etc. It generally has sub-committees made up of board members with a particular expertise.

Question 40

Responsibilities of the audit committee

Answer 40

1) Oversight of financial reporting function and implementation of accounting policies 2) Verifies the effectiveness of the company's internal controls and auditing procedures 3) Recommends an external auditor and its compensation 4) Proposes remedies based on the review of internal and external audits

Question 41

Nominating/governance committee responsibilities

Answer 41

1) Oversight of corporate governance code 2) Sets policies for nomination of candidates for board membership 3) Implements the company code of ethics and policies regarding conflict of interest 4) Monitoring changes in relevant laws and regulations 5) Ensuring compliance with laws, regulations, and internal policies

Question 42

Functions of the compensation/remuneration committee

Answer 42

1) Recommends to the board the amounts of and types of compensation to be paid to the directors and senior managers. 2) May also be responsible for oversight of employee benefits plans and evaluation of senior managers.

Question 43

Risks of poor governance and stakeholder management

Answer 43

1) Accounting fraud 2) Self serving by management 3) Legal and reputational consequences 4) Debt default and bankruptcy

Question 44

Benefits of good governance and stakeholder management

Answer 44

1) Improved operating performance 2) Effective control and monitoring 3) Compliance with laws and regulations 4) Reduced default probability and lower cost of financing 5)

Question 45

Cash conversion cycle (definition and formula)

Answer 45

CCC represents the time it takes for a company to convert its cash outflows from investment in inventory and other resources into cash inflows from sales. CCC = Days of inventory on hand + Days of sales outstanding - Days of accounts payable outstanding (DOH, DSO, DPO)

Question 46

Total working capital formula

Answer 46

Current assets - Current liabilities

Question 47

Net working capital formula

Answer 47

(Current assets - Cash&Cash equivalents - Marketable securities) - (Current liabilities - short term and current debt)

Question 48

Primary and secondary liquidity sources

Answer 48

Primary - cash and marketable securities, bank borrowings, cash generated from the business Secondary - Suspended or reduced dividends, delayed or reduced capital expenditures, selling assets, equity issuance, debt restructuring, bankruptcy protection filing

Question 49

Drag on liquidity

Answer 49

Occurs when cash inflows lag. This means that either or both days of inventory at hand and days of receivables outstanding increase.

Question 50

Pull on liquidity

Answer 50

Occurs when cash outflows quicken. This happens when less credit is extended to the company or is extended under worse conditions, so days of payables outstanding decrease.

Question 51

Explain the difference between current, quick, and cash ratios

Answer 51

CR = current assets / current liabilities QR = (cash and marketable securities+ acc. receivable)/current liabilities CR = cash and marketable securities / current liabilities

Question 52

Types of capital investments (list and define)

Answer 52

1) Going concern project - Investments needed to maintain the business and/or reduce costs 2) Regulatory/compliance projects - may be required by a government or insurance company and often involve environmental and safety concerns. 3) Expansion projects - Investments which grow the business and require complex decision-making process that includes future demand etc. 4) Other projects - one example is an investment outside of the company's line of business, also require complex decision-making process due to complexity involved.

Question 53

Four steps of the capital allocation process

Answer 53

1) Idea generation 2) Analysis of project proposals 3) Creating a firm-wide capital budget - Firm sums its resources and checks profitability and strategic appropriateness of potential projects offered. 4) Monitoring decisions and conducting post-audits - Comparison of realised and forecasted project metrics, explain why deviations occurred. The post-audit should be used to identify systematic mistakes in forecasting and improve company operations.

Question 54

Net present value

Answer 54

Sum of present values of all the expected incremental cash flows if a project is undertaken. The discount rate used is the firm's cost of capital adjusted for project riskiness.

Question 55

Internal rate of return

Answer 55

A discount rate which equates the project cost with the present value of all after-tax cash flows from the project.

Question 56

Key advantages and disadvantages of NPV and IRR as investment project profitability measures

Answer 56

NPV: - key advantage is that it provides a direct measure of expected increase in the value of the firm. IRR: - advantages: measures profitability as percentage, it provides info on the margin of safety since it is compared to the cost of capital - disadvantages: it assumes that cash flows are re-invested at IRR, while NPV assumes they are reinvested at cost of capital, it may have multiple solutions when calculated so in that case interpretation is dubious

Question 57

Return on invested capital (ROIC) (formula)

Answer 57

net operating profit after tax (net income + after tax interest expense) (EBIT - tax) / average book value of capital invested

Question 58

Key principles of the capital allocation process

Answer 58

- Decisions are based on after tax cash flows, not accounting income - Incremental cash flows are the only ones taken into considerations - i.e. no sunk costs included and cannibalisation must me accounted for - Timing of cash flows is important given we are working with time value of money

Question 59

Types of cognitive errors in capital project evaluation

Answer 59

1) Poor forecasting 2) Not considering costs of internal funds 3) Incorrectly accounting for inflation

Question 60

Types of behavioural biases in capital project evaluation

Answer 60

1) Pet projects of senior management 2) Inertia in setting the capital budget 3) Basing investment decisions on ROE or EPS to pander to markets in the short run 4) Failure to generate additional investment ideas

Question 61

Real options (definition and type list)*

Answer 61

Real options are future actions that a firm can take, given that they invest in a project today, i.e. they give the right but do not oblige to take an action in the future. Types of real options include the following: 1) Timing options - allow investment delay to await more information 2) Abandonment options - allow project abandonment if the pr. value of its cash flows from exiting exceeds the pr. value of those from continuing operations. 3) Expansion options or growth options - allows additional investment if the value added is positive 4) Flexibility options - allow choices regarding operational aspects of the project, two key ones are price-setting options and production-flexibility options 5) Fundamental options - are projects which are options themselves because they depend on the value of an underlying asset.

Question 62

MM 1 and its assumptions

Answer 62

Modigiliani Miller hypothesis result 1 states that, in the absence of taxes, the company value is not affected by its capital structure, under the assumption that: 1) Perfectly competitive capital markets 2) Homogenous investor expectations 3) There is riskless borrowing and lending 4) There are no agency costs 5) Investment decisions are unaffected by capital structure

Question 63

MM2 and assumptions

Answer 63

Modigiliani Miller hypothesis result 2 states that the cost of equity increases linearly as a company increases its proportion of debt financing, while the total WACC remains the same. This holds under the standard five MM assumptions: 1) Perfectly competitive capital markets 2) Homogenous investor expectations 3) There is riskless borrowing and lending 4) There are no agency costs 5) Investment decisions are unaffected by capital structure

Question 64

Static tradeoff theory of capital structure

Answer 64

A capital structure theory which posits that the observed debt levels of a company are made at the level which maximises firm value by trading off marginal tax shield value of debt and marginal cost of expected financial distress in present value.

Question 65

Target capital structure

Answer 65

The capital structure that a firm seeks to achieve on average over time to maximise expected firm value. Calculated via internal book value of each component of capital.

Question 66

Definition and three components of net agency costs

Answer 66

Costs of conflict of interest between the principal and agent after the principals take steps to mitigate the cost. Three components of net agency costs are: 1) Monitoring costs - come from supervision of the agent 2) Bonding costs - come from assurance of interest alignment between the agent and principal 3) Residual losses - losses occurring due to the conflict after adequate monitoring and bonding provisions.

Question 67

Free cash flow hypothesis

Answer 67

A hypothesis which states that the use of debt forces management to be disciplined with respect to cash expenditures given that they have less free cash flows after servicing debt.

Question 68

Pecking order theory

Answer 68

A theory of capital structure which states that managers will seek to maximise the value of the company by minimising negative signals sent to investors via financing decisions. This makes them prioritise financing sources with low negative information content, i.e their preferred financing sources go in this order: internal funds, debt issuance, equity issuance.

Question 69

Business model

Answer 69

A document/description of how a firm provides a product, finds customers, delivers the products, and make profit, i.e. it provides info on the following: 1) Who - Identify the firms potential customers via their segments, and how will they be acquired and maintained 2) What - Describe the firms product or service, that is how it meets the needs of the potential customers. 3) How - Describe the key assets and suppliers of the firm 4) Where - how will the firm sell its product or service, i.e. the distribution channel 5) How much - Explain the pricing strategy given the competitive market and customer characteristics

Question 70

Price discrimination methods in selling one product

Answer 70

1) Tiered pricing - price discrimination based on volume sold to each individual customer, i.e. bulk discounts 2) Dynamic pricing - price discrimination based on the time of sale, like discounts in low-congestion periods 3) Value-based pricing - p.d. based on marginal improvements to the quality of the product 4) Auction pricing

Question 71

Pricing discrimination models for multiple products

Answer 71

1) Bundling - selling complimentary products together so as to achieve a larger price than a sum of each's prices. 2) Razors-and-blades - Selling a piece of equipment at low margin and consumables used with equipment at high margin so as to achieve consumer captivity. 3) Add-on pricing - Options and add-ons being made with high margins after the product purchase decision has been made. Example is the pricey options offered after car purchase.

Question 72

Other pricing models (Penetration, freemium, and hidden revenue pricing)

Answer 72

1) Penetration pricing - Initially offer a product at low or negative margin to achieve a growing market share and achieve greater scale of operations. 2) Freemium pricing - offer a product with basic functionality for free, but then sell and unlock additional functionalities for a high margin. 3) Hidden revenue - offer a basic product for free, the use of which by customers can create opportunity for selling of profitable services or products. Classic example is social media, search engines and other platforms.

Question 73

Models that offer alternatives to outright purchase

Answer 73

1) Subscription models 2) Licensing and franchising

Question 74

Value proposition

Answer 74

A proposition on how will the customers value the characteristics of the good offered, given the competing products and their prices.

Question 75

Conventional business models

Answer 75

Tend to be industry-specific, like natural resource producers, manufacturers, wholesalers, retailers, banking, insurance etc.

Question 76

Other business models

Answer 76

1) Private label manufacturers and contract manufacturers - Companies that produce products for others to market under their own brand names. 2) Licensing agreements - A company's brand is used on other companies' products for a fee (think Marvel lunch boxes). 3) Value-added resellers - installation, servicing, support or customisation for complex equipment.

Question 77

Network effects

Answer 77

Refer to the effect of increased value of the network with the increase in its user base.

Question 78

Crowdsourcing

Answer 78

Business models which benefit from user contributions, like Wikipedia or Reddit.