General Flashcards
Modigliani–Miller theorem
The capital structure is a irrelevance principle.
Consider two firms which are identical except for their financial structures. The first (Firm U) is unlevered: that is, it is financed by equity only. The other (Firm L) is levered: it is financed partly by equity, and partly by debt. The Modigliani–Miller theorem states that the value of the two firms is the same.
defensive tactics pre and post bid
Pre: communicate effectively with shareholders revaluate non-current assets poison pill strategy super majority
Post: appeal to own shareholders attack bidder White Knight Counterbid or Pacman defence Competition authorities
Also positive and negative covenants
Positive Covenant
A bond covenant that requires the issuer to take certain actions. For example, a positive covenant may require an issuer to maintain enough liquid assets to cover the principal of the bond. More commonly, a positive covenant requires the issuer to have a certain amount of insurance or submit to periodic audits. It contrasts with a negative covenant, which prevents the issuer from taking the enumerated actions. It is also called an affirmative covenant, ie certain ratios, GAAP reporting, audited financials, perform maintenance on assets, maintain life insurance on certain employees, pay taxes timely.
‘Negative Covenant’
A bond covenant preventing certain activities, unless agreed to by the bondholders. Negative covenants are written directly into the agreement creating the bond issue, are legally binding on the issuer, and exist to protect the best interests of the bondholders. Also referred to as “restrictive covenant”, ie dividends, further debt, sell assets, certain leases, takeover or merger, change salaries.
Adjusted Present Value (APV)
Adjusted Present Value (APV) is an approach to investment appraisal that should be used if the if the financial risk of the company is expected to change significantly as a result of undertaking a project.
APV = NPV + Financing Impact
The Capital Asset Pricing Model (CAPM)
The CAPM shows how the minimum required return on a quoted security depends on its risk.
The required return of a rational risk-averse well-diversified investor can be found by returning to our original argument:
Required Return = Risk Free + Risk Premium
NPV with taxation
When appraising capital projects, basic techniques such as ROCE and Payback could be used. Alternatively, companies could use discounted cash flow techniques such as Net Present Value (NPV) and Internal Rate of Return (IRR).
When calculating the WACC, the cost of debt should always be a “post tax” figure - i.e. has been adjusted for the tax relief on interest. This is the normal way of determining the WACC so no extra work is required.
Poison Pill Strategy
A shareholder rights plan, colloquially known as a “poison pill”, is a type of defensive tactic used by a corporation’s board of directors against a takeover. Typically, such a plan gives shareholders the right to buy more shares at a discount if one shareholder buys a certain percentage or more of the company’s shares.
Takeover methods considerations (3)
Cash:
PRO: quick at low costs, certainty about bid, easy for investors to realize investment, less risk
CON: usually requires borrowing cash, taxable, no participation in new company
Share exchange:
PRO: non-cash, “boot strap” E/P, shareholder capital increase, possible to fund large acquisitions.
CON: sharing of future gains, risk of falling share price of bidder.
Earn out:
refers to a pricing structure in mergers and acquisitions where the sellers must “earn” part of the purchase price based on the performance of the business following the acquisition.
Bootstrapping the P/E ratio
A CORPORATE FINANCE practice where an acquirer buys a company with a low PRICE/EARNINGS RATIO through a STOCK SWAP in order to boost the post acquisition EARNINGS PER SHARE (EPS) of the newly formed group and create a rise in the stock price.
problems with non-financial reporting
Relevance
Reliability
Comparability
Derivatives Types (5)
Forward Forward rate agreements Futures contracts Swaps Options
Derivatives Accounting Standards
IAS39: Recognition and measurement
IFRS 7: disclosure (assets and liabilities)
IFRS 9: to be implemented Jan 2018 supersedes IAS39
Disclosure and measurement
IFRS 7
significance
nature and extent of risk
qualitative and quantitative
Risk Categories:
credit risks
liquidity risks
market risk
Financing Criterias
Cost
Duration
Lending restrictions
Gearing
Currency associated with the cash flow (in/out)
Impact on financial statements, tax, stakeholders
Availability
Preference shares
post tax (compared to debt) paid as fixed proportion of share
Types:
cumulative (skipping a payment will have to be paid later)
non-cumulative (skipping possible)
participating (similar to ordinary shares)
convertible
Types of companies
Ltd: limited by shares
plc: Public limited company
Pro IPO and Con
PRO accurate valuation realization of paper profits raise profile of company raise capital in the future more accessible employee participation
CON costly loss of control reporting requirements stock exchange rules
Fair value hedge definition IAS 39
A firm commitment is a binding agreement for the exchange of a specified quantity of resources at a specified price on a specified future date or dates.
A hedge of the exposure to changes in highly probable fair value of a recognised asset or liability;
an unrecognised firm commitment, or an identified portion of an asset, liability or firm commitment
that is attributable to a particular risk and could affect profit or loss.
Residual Dividend Policy
Companies using the residual dividend policy choose to rely on internally generated equity to finance any new projects. As a result, dividend payments can come out of the residual or leftover equity only after all project capital requirements are met. These companies usually attempt to maintain balance in their debt/equity ratios before making any dividend distributions, deciding on dividends only if there is enough money left over after all operating and expansion expenses are met.
Ungeared Cost of Equity
Using the ungeared cost of equity is ‘measuring’ how good the project is, completely ignoring the effect of using any debt finance.
Then we are calculating separately the benefit of using the debt.
(Discounting the project at the WACC takes account of both effects at the same time, but the problem is that this assumes that the gearing does not change. The APV allows us to deal with changes in the gearing.)
Calculated intangible value
DEFINITION OF ‘CALCULATED INTANGIBLE VALUE - CIV’
A method of valuing a company’s intangible assets. This calculation attempts to allocate a fixed value to intangible assets that does not change according to the company’s market value. Examples of intangible assets include brand equity and proprietary technology.
Usually a company’s intangible assets are valued by subtracting a firm’s book value from its market value. However, opponents of this method argue that because market value constantly changes, the value of intangible assets changes also, making it an inferior measure. Finding a company’s CIV involves seven steps:
- Calculate the average pretax earnings for the past three years.
- Calculate the average year-end tangible assets for the past three years.
- Calculate the company’s return on assets (ROA).
- Calculate the industry average ROA for the same three-year period as in Step 2.
- Calculate excess ROA by multiplying the industry average ROA by the average tangible assets calculated in Step 2. Subtract the excess return from the pretax earnings from Step 1.
- Calculate the three-year average corporate tax rate and multiply by the excess return. Deduct the result from the excess return.
- Calculate the net present value of the after-tax excess return. Use the company’s cost of capital as a discount rate.
Unsystemic risk
Unsystematic risk, also known as “specific risk,” “diversifiable risk” or “residual risk,” is the type of uncertainty that comes with the company or industry you invest in. Unsystematic risk can be reduced through diversification.
TERP
theoretical ex-rights issue
The theoretical ex-rights price (TERP) of a share
The new share price after the issue is known as the theoretical ex-rights price and is calculated by finding the weighted average of the old price and the rights price, weighted by the number of shares.
The formula is:
TERP = (cMarketCap + proceeds) / (# old + new shares)
CAGR
compounding average growth rate
CAGR = (Xy/Xo)^(1/n)-1
Scrip dividend
A scrip issue, also known as capitalisation issue or bonus issue, is a form of secondary issue where a company’s cash reserves are converted into new shares and given to existing shareholders.
Dividend reinvestment plans give shareholders the opportunity to use the cash dividends on their shares to buy more shares in the same company. With a Scrip dividend, new shares are issued by the company, which can be acquired by investors instead of a cash dividend payment.
Finance lease
Operating lease
Fin: transfer of risk and reward; asset in BS
Op: does not transfer risk and reward; P&L
Thin capitalisation rules
prevent intercompany transfer of profits. gearing and interest rate should be at market conditions.
Residual dividend
only pay dividend if no other positive NPV projects are available
Rachet dividend pattern
dividend lags behind earnings growth
Asset stripping
Predator acquisitions, selling assets, closing some operations.
beta formula
riskfree - (marketrisk - riskfree)xbeta = cost of equity
beta = (Rf - Ke) / (mR-Rf)
Druker post acquisition integration (5)
ensure common core (tech, market)
common benefit (us and them)
respect acquired products, customers and markets
get top mgmt for new Co within 1 year
within 1 year cross entity promotions
