For Final Flashcards
OCF =
EBIT*(1 - Tax) + Depr
NCS =
End NFA - Beg NFA + Depr
Depr =
(Cost - BV at Salvage) * Depr Rate
AT SV =
MV - Tax * (MV - BV)
inflow of cash is () for NCS
negative
rf represents
pure time value of money
market risk premium
diff b/w expected return on market portfolio & risk free rate
____ stocks earn more than predicted
low beta
small company
value
momentum
firm value with WACC =
cash0 + sum of all future FCF discounted at WACC
___ is (corporate) tax deductible, ____ is not
interest; dividends
expected interest exp each year
D * rd
expected TS each year
D * rd * Tc
value of perpetual debt
D*Tc
debt overhang
existing debt and the potential for distress cause shareholders to forego +NPV projects
assuming situation where shareholders would fund project
risk shifting
more debt is bad
shareholders have incentive to take on riskier projects in presence of debt (and thus gamble w/debt holders $$)
manager risk aversion
more debt is bad
manager wants to reduce personal risk in face of large financial risk
FCF problems
more debt is good
debt acts as disciplinary device
Trade off theory
VL = VU + PVTB - PVDC - value lost from excess risk-taking - value lost from manager risk aversion + value gained from disciplining debt
signal from using internal funds
+, has enough CFs to finance business
signal from using debt
+, low risk of future financial distress
signal from issuing equity
-, signals that managers believe the firm is over-valued
Calculating FCF in AHP case
Δexcess cash = FCF - net financial cash outflows
Amount added to excess cash comes from FCF that isn’t paid out in dividends, interest, etc
dividend growth model
P0 = [ DPS0 * (1+g) ] / (re - g)
if x denotes the ratio PVDC/VL, then PVDC =
x * [ (VU + PVTB) / (1 + x) ]
key assumptions of perfect capital markets & div policy
firm always undertakes all +NPV projects
firm finances itself @ fair market rates
excess cash invested in correctly-priced securities
firms with more investment opps will pay ____
less dividends
if corporate tax
less dividends; keep cash in the firm and reinvest it on behalf of shareholders, then pay out returns as a dividend
if capital gain tax
less dividends
clientele effect
some clients will prefer diff div policies; they might pay diff tax rates on div income and capital gains
dividends may act as a signal
since it’s a commitment, consistent divs will incr investor’s perception of firm’s strength
issuing securities is $$$
ex. underwriter fees
dividends can be used to reduce ___ ___
agency conflicts
reasons for share repurchase
tax adv if capital gains tax
B-S assumptions
can buy/sell stock @all times no transaction costs unlimited borrowing/lending @ rf constant risk-free rate and volatility stock price is log-normally distributed stocks DON'T pay divs until after exp date
option value relationship w/ sigma
option value will INCR with INCR in sigma
unlimited upside potential, limited downside risk ( since we won’t exercise option if price is very low)
B-S limitation: Dividends
assumes no dividends until after T
if there ARE dividends, they’re paid to actual shareholders and not option holders; you have to adjust by subtracting from price
B-S limitation: Horizons
overprices LT options bc B-S assumes variance grows proportionally with time horizon
True variance is not going to be as large over long time periods –> a too high variance = too high options price
call option & P
+ relationship, more likely to be in the money w/ higher current price
call option & X
- relationship, more likely to be in the money w/ lower strike price
call option & rf
+ relationship, increase in rf reduces PV of X
PV of X =
X / (1 + rf)^T
call option & sigma
+ relationship, unlimited upside, limited downside
call option & T
+ relationship
volatility scales up w/ time horizon
PV of exercise price decreases
put option & P
- relationship; more likely to be in the money w/ lower underlying price
put option & X
+ relationship; more likely to be in the money w/ higher strike price
put option & rf
- relationship; higher rf reduces PV of X that we’ll receive when we sell the underlying asset
put option & sigma
+ relationship; gain from downside, protected from upside
put option & T
+ and -
+ from rising volatility w/ T
- bc increase in T decreases PV of X
put-call parity
Call0 + PV(X) = Put0 + P0
where PV(X) = X / (1+rf)^T
valuing warrant bond component
bond value = C*(annuity etc) + F/(1+r)^T
warrants: P
a * Y
a = n / (n+m) n = #new shares to which ALL convertible bonds will be converted (s*k)
warrants: X
k*F
Y for warrants
firm value - debt
OR
current MV of equity + cash proceeds from convertible bond issuance
callable convertible bond
less exp bc more restrictions
can lessen financial distress by reducing leverage
