FIN 401 Flash cards

Question 1

5 M&M assumptions

Answer 1

1) No taxes
2) No costs of financial distress
3) No asymmetric information
4) There are perfect capital markets
- No transaction costs.
5) No agency problems

Question 2

Interest tax shield

Answer 2

A reduction of taxable income for a corporation achieved by claiming deductions, such as interest on debt.
-The tax shield is employed as soon as you take on debt.

Question 3

What are Investors

Answer 3

Creditors

Question 4

How to find the dollar amount of tax shield.

Answer 4

D*T(tax rate)

Question 5

Why does the debt overhang problem make it difficult for firms facing financial distress to finance projects with new equity?

Answer 5

It is difficult for shareholders to invest in new projects during financial distress because there is a good chance that the profit will solely go to the debt holders.

Question 6

Would a software/tech company or an auto industry face more difficulty during times of financial distress? Why?

Answer 6

The Software company because a good portion of its assets are intangibles which are very illiquid. That is why tech companies usually finance their company through equity not debt.

Question 7

Times-INterest-Earned

Answer 7

EBIT / Interest Expense

Question 8

CAPM

Answer 8

E[r] = Rf + B*(Rm-Rf)

Question 9

How do you unlever Be ?

Answer 9

Ba = Be*(E/V)

Question 10

Steps of finding a firms Cost of Equity using Comparables

Answer 10

1) Get the Be’s and unlever them using Ba = Be*(E/V)
2)Average the Ba’s that are found.
3) Reliever the averaged Ba’s using the target D/V
Be = (Ba/E/V)
4) Then plug in the new found Beta into the CapM

Question 11

Perpetuity equation for IRR

Answer 11

CF/IRR = cost