Forgets Flashcards
IRR rule if - CFS front/back loaded
front
IRR> r
back
IRR< r
IRR assumes
all FCFs reinvested at IRR
MIRR 3 different approaches
Discounting
- disc all -CFS back to 0
Reinvestment
- put all CFS but CF0 forward to end
Combination
- both disc - CFS to 0 and put all other Cfs forwards to end
NPV and IRR give same decision BUT
mutually exclusive (CFo and timing very different)
non-conventional CFs
Payback Period problem
NPV could be -
PI helpful when
funds are limited
Dep Tax Shield
Tc x Dep
3 techniques for comparing mutually exclusive projects with different lives and which method to use
LCLife
NPV Perpetuity
Equivalent Annul Cost
- identical r give all same
- diff r use NPV perp first, LCF and NPV give different and then never use EAC
scenario vs sensitivity analysis
sensitivity is effect of change of one avr and scenario is whole bunch of assumptions
What about NPV at accounting BE?
-
Acct vs Finc BE
when net profit=0
sales when NPV=0 or IRR=r
real and financial options represent ____ to __( end part diff for each)
the right but not obligation to
real: take some action in future
finc: purchase something in future for price set today
3 real options
expand, delay, abandon
what 4 things need to be true for options analysis to exist in real investment analysis
flexbility
uncertainty
learning
irreversibility
2 limitations to real options
increase capital investment values which increase agency risk
assumes perfect foresight
goal for capital structure
minimize WACC, maximise firm value
business risk
equity risk arising from nature of firms operating activities and is directly related to systematic risk of firms assets
financial risk
equity risk arising from capital structure of firm
when earnings perform good and and with debt and what is BE
good: EBIT> BE pt
bad: EBIT< BE pt
BE pt: EPSu=EPSl
why lev increases ROE if ROA>Rb
as ROA measures how efficiently a company’s assets can generate profits.
if RA>Rb it means the company is earning more from its investments than it is paying in interest
Homemade leverage
Unlev + Lev
Not paying int but want to, Shint gonna be -
Borrow D/E of shares owned money from bank at same rate as firm and use to buy shares
CF going to be EPSU x new number shares (more than before) - SH int
De-lever
Lev + de-lever
Paying int but don’t want to so going to receive int
Sell D/V shares and put those into bank at same rate as firm
CF going to be EPSL x new shares owned(less) + SHint
MM1,2,3
value, Rs, WACC
MM1,2,3 with and without taxes
without
1
Vu=Vl, cap structure/debt is irrelevant
2
Rs is increased with D as shareholders need compensating
3
WACC u=WACC l=Ro
with taxes
1
Vl= Vu+ TcB (dtax shield), debt increases value of firm
2
cost of eq to lev firm is cost of unless firm plus risk premium
3
lev firm WACC is lower as increased value
Int tax shield
Rb x D x Tc
D/E to D/V
D/E/ 1+ D/E
D/V to D/E
D/V/ 1-D/V
2 critiques of MM props
personal tax disadvantage of debt makes corp tax advantage ineffective
borrowers incur side costs of debt (bankruptcy costs and agency costs of debt) which can offset value of int tax shield
who bares future costs of bankruptcy?
shareholders
3 selfish strategies shareholders take and why?
underinvestment
- shareholders would be wanted to put more money in so that increased debt holder value
take large risk
higher risk
- -NPV projects destroy value to bondholders
milking it out
- pay out extra divs to decrease value to bondholders
2 ways to decrease agency costs of debt
repurchase debt prior to bankruptcy
increase return to bondholders
trade-off theory of debt
trade-off between PV debt tax shield and costs of financial distress
optimal cap structure is ___ but firms are
static
dynamic
debt 2 adv and disadvand their implications
adv
- tax benefit (lowers taxable income), higher Tc higher advantage
-reduced agency costs equity, increases cost of equity: FCF possible wasteful managers, makes them work harder , as sep between stock and managers increase, benefits ti using debt increase
disadvantage
- agency costs of debt(shareholders being sneaky), firms where lenders have control over how monry used should be able to borrow more
- bankruptcy costs, firms with more stable earnings and lower bankruptcy costs should borrow more
MM and personal taxes
with
Gain lev= TcB if TPs=TPb
without
Gain lev=0 if (1-Tc)(1-Tps)=(1-Tcb)
classical tax system
double taxation
favours corp debt
many outcomes depending on individuals tax rate and D/E ratio
imputation tax system
Tc=0
corporate profits are taxed at the corporate level, but the tax paid by the corporation is credited to shareholders when they receive dividends
no tax adv of debt
eq income oney taxed at personal tax rate
debt is not attractive
if management know Veq<Market value
they will issue shares and @announcement investors learn so SP decreases
pecking order theory
ret earnings (cheapest), debt, equity
according to pecking order theory what should happen on announcement of debt
negative impact on SP
according to pecking order theory if internal CF> cap investment
surplus used to pay debt
3 conflicts of pecking order theory with trade-off theory
no target D/E
profitable firms use less debt
firms like financial slack and like to have cash readily avaliable
factors in D/E ratio
taxes
type of assets
uncertainty of operating income
When to use APV, FTE, WACC
APV when level of debt is known
FTW when large levered firms
WACC most common
working out D+S=V in APV
APV becomes V and D is amount of loan
APV and floatation costs
minus from loan amount and then add PV of Fcost tax shield so each years amont x Tc present values
NPVF of loan
+ in year 0 of loan, - AT int payments each year - principal loan at t
NPV all eq if depreciation is risk less
- price + EBTD x (1-Tc) x PVIFA + PV Deep tax shield(Dep x Tc x PVIFA), remember to disc dip tax shield at diskless rate
4 financing side effects
tax subsidy to debt
costs of issuing new securities
costs of financial distress
subsidies to debt financing
3 ways to value a firm with debt
APV, FTE, WACC
NPVF for 3 diff financing side effects
tax subsidy to debt
= PV (int tax shield)
costs of issuing new securities
= NPV (floatation costs)
subsidies to debt financing
= NPV (loan)
in a non-perpetual analysis FTE approach
LCF= UCF- AT financing expense
at t LCF will be UCF- AT financing expense -loan
discount LCF at levered Rs
calc Rs by V=APV
year0 - debt amount from initial
years 1-t normal CF- at int payment
year t -off whatever the loan amount
equity value can __ but debt __
flucuate
can’t
in a perpetual analysis FTE approach
net income/Rs (net income being Earning after interest after depreciation)
WACC method
discount UCF at WACC
scale enhancing project
similar to those of firms existing assets
non-scale enhancing project
different area
Asset B
B0=Ba=Bunlev
Equity B (lev B)
Beq=Bs
Beta infos with and without corp taxes
without
Bd=0
with
Bs>Bunlev
Bs is __ related to lev of firm
+
pure play
de-lever Bs to get Bo for PP using PP D/E
re-lever Bo using D/E of projects firm
Opportunity cost
value of the best alternative forgone where, given limited resources, a choice needs to be made
Nominal CFs
actual dollar amount received
Real CFs
refers to CF purchasing power
after 1st year abandon project if __ and sales Q of this
PV of FCFS< selling amount
equate PV FCFS to abandon value and solve for q
Net income for a firm with debt
EBIT- Int (Rb x D)
what happens to S.O in a share repurchase
decreases
return of divs
divs/owns stocks
increase in value of a firm with int
PV int tax shield (B x Rb) x Tc
value to shareholders/ of equity after payments to debt holders
is residual value after paid debt holders
make stockholders indifferent to debt holders increasing payment make
E(Ve) low vloatility= E(Ve) high volatility and make high vol one have x in it
promised vs expected return to debt holders
face value/MV debt - 1
expected value debt/MV debt -1
How to work out how many shares currently held will need to purchase a new share?
RI terms: shares on issue/number new shares
RI terms
1:16 or 16 means can buy one extra for every 16 held
Shares on offer/ number rights given out
(number of shares held to be entitled for a right)
n and r in theoretical value of a right formula
n is RI terms (number of shares held to obtain a right)
r additional shares offered for each right (2:1 offering 2 for every 1 so additional is 2)
RI shareholder wealth after
bought RI x shares owned number of shares
(new number shares owned x Pex) - (number shares bought x sub price)
RI options if or if not rennouncable
if :
can sell their rights to maintain wealth level
if not:
prefer whichever plan decreases SP by littlest as RI can dilute shareholder wealth
Winner’s curse
Profit if UV and OV
= no shares(UV amount)-no shares(OV amount)
but then UV only recieve half
Cash offer with x required sale proceeds
X*(1-UW %)=Raise
main reason to lease
tax deductibility of lease payments
operating vs financial lease
operating like a rental agreement, lessor still own and maintain lessee pay payments, can cancel, not fully amortised
financial, lessor doesn’t maintain more flexibility for them, fully amortized, lessee becomes owner at end
2 types of financial lease
sale and lease back
leveraged lease
4 conditions for a financial(capital lease)
PV lease payments > 90% of Mv of asset
Bought by lessee at end
lease life>75% of assets life
lessee has a bargain purchase option at expiry
2 things i forget for NAL
discount at after tax cost of debt
if paid at start of year lay out which years are what for accurate PVIFA/discounting
lessor req payments
amount to be amortized= initial outlay- PV AT salvage- PV deep tax shield and amount amortized= PV AT lease income which = PVIFA x AT annual lease payment so lease payment =AT lease /(1-tc)
debt displacement and lease
The reduction in a company’s ability to borrow because it leases its assets. debt displacement occurs when a company receives income from its leases, it prevents the company from using those assets as collateral for a loan.
if lease not use as much debt as if borrowed to buy
lend more to purchasing firms as they are using more debt capacity s can cover from int side of things
when to carry more debt under purchase option
AT CFs buy> AT lease payments
the NAL= ? when firms indifferent to buy or lease
NAL=0
recognise residual dividend policy
it is if CAPEX< EPS and any div, not if other ways round and paying div as investment funding would require more than earning so should not be any divs paid should all go to capex
recognise smoothed dividend policy
div payout ratio equal ish
Payout: Div per share/EPS
recognise stable dividend policy
stable stream of dollar dividend payments, which are expected to increase over time in line with permanent increases in firm earnings.
if EPS increasing and Div per share makes sense
low regular plus extra policy
pay low stable amount to give shareholders consistent income then extra if doing well
in finc206 does share repurchase change shareholder wealth
no as can sell shares for 46 or keep shares worth 46 as SP doesn’t change
prefer extra div or shares repurchase
shares repurchase keeps SP high and gives options to sell or keep
MM irrelevance theory
dividend policy is irrelevant , payin div or issuing new shares DOESN”T change shareholder wealth or firm value
ex div day
owners on or after won’t receive div
typically share price falls by
less than div amount due to taxation
div policy is trade-off
between retaining earnings for investment or paying out divs and issuing new shares to replace cash paid out
gain in div income for shareholders is
offset by loss of capital gains
in div imputation system how much does SP fall by?
> tan div due to value of franking credit
in div imputation system firm essentially
pays tax on div income on behalf of shareholder
non-tax relevance of div policy (
info signalling
current income prefs
div stability
decrease in agency costs
share issue cost for firm
transaction costs for investors
clientele effect ( firms adopt div payout policy for which there is excess demand)
Pcum
share price just before stock pays div
Current return for shareholders
(Divs(x growth rate maybe)/Shares) + growth rate
value of target firm to acquiring firm
number of shares outstanding times the price per share under the new growth rate assumptions
gain from acquisition
value of the target firm to the acquiring firm minus the market value of the target
NPV acquisiton
value of the target firm to the acquiring firm minus the cost of the acquisition
Max acquiring firm pay per share
value of the target to the acquirer divided by the number of target’s shares
share price in merged firm
MVA + value of B to A / Shares A+Shares B
for a stock offer to be equivalent to cash offer
set the value of the share exchange offer equal to the value of the cash offer: Vab*h= cash offer
shareholders of target would be equally well off if they received this % of stock in new company
Ownership % of target shareholders in new firm
Ownership %= new shares issues/ (new shares issues+ current shares of acq firm)
exchange ratio
The exchange ratio is the number of shares of acquiring firm offered for each share of target firm
Exchange ratio = New shares issued/ Existing shares in target firm
increase eco of scale
spread FC over more units
increase eco of scope
benefits from enhancing breadth of g/s
7 motives for acquisition
synergy creation, economic gain
operating synergies
financial synergies
revenue enhancement
cost reduction
tax gains
reduced capital requirement (disposal of duplicated fixed cap/WC)
CCC formula and each formula
Inv day+ A/R days- A/P days
Inv days:
Inv/ave daily COGS
A/R
A/R/ ave daily sales
A/P
A/P/ave daily COGS
commitment fee you pay on
unused portion
pay int on total not fee
then pay fee on unused
compensating balance
hold % in acct so only receive amount-holding
pay int on full and maybe on balance too
payback= (borrowed total+int)- (holding+holding int)
loan % IR 2 things
pay/recieved-1 and EAR it
if it says compensating balance on face value
amount + fees / (1-%)
Cfs for NPVF
floatation cost
loan/tax subs
if not loan just PV after-tax int payments
floatation cost
year 0 - float cost
other years inc at end + float cost tax shield
loan
year 0 + loan given
years 1-t -after tax int payments
t inc after tax int payments, - principal pay back of loan
