Module 4 Flashcards
financial obligations > financial assets (net debt)
positive net financial obligations
financial obligations < financial assets
negative net financial obligations
Flev > 0 (positive flev) when…
When financial obligations > financial assets
obligations incurred to fund the business
financial obligations
commercial paper, loans payable, bonds payable, accrued interest
examples of financial obligations
lease obligations, defined benefit pension liabilities, FV of an out of the money interest rate swap
financing activities
Three benefits of positive flev
interest tax shield, mitigate information asymmetry, higher goal congruence
Costs of positive flev
costs of financial distress (direct and indirect)
All else equal the cost of ____ is less than the cost of _____.
borrowing, equity
What is the pecking order?
internal capital, borrowing and as last resort equity
What is information asymmetry?
managers and investors have different goals - left to own devices managers will destroy value
Why does levering up create value?
forces mgmt to act like owner bc debt holder can take control if now
when a company is unable to honor the terms of its loan contracts/bond indentures
financial distress
direct costs of financial stress
legal, consultant, audit fees
indirect costs of financial distress
diversion of mgmt attention away from ops, feedback effects sales (GMotors example), cost related to shareholder/creditor conflict
also known as parked cash, when company doesn’t have significant influence and investment is not held up as part of the joint venture, partnership or other synergistic relationship (bonds , mutual funds, index funds, marketable securities)
passively owned financial securities
Benefits of negative flev
shield unremitted foreign earning from being taxed in US, mitigate information asymmetry
Negatives of negative flev
interest income is taxed, lower goal congruence
