Module 5 Flashcards
represents the funds used to finance a firm’s assets and operations
Capital
minimum (hurdle rate) of return which a frim must earn on its investments to provide a return to the providers of the funds based on the risk of the assets
how the market views the risk of the firms assets and they are used
if investors are compensated for their financing the frim must earn a return higher than the cost of financing
a % return
Cost of Capital
how the market views the RISK of the firms assets and how they are used
Cost of Capital
the required return on the overall firm
also the rate appropriate for cash flows that are similar in risk to those of the overall frim
Weighted Average Cost of Capital (WACC)
rate that must be earned on an investment project if the project is to increase the value of the common shareholders investment
also be referred to as the firms opportunity cost of capital
if financed with equity capital the cost of ___________ is equal to the required return on common stock
if a frim were to earn its __________ we would expect the price of its common stock to remain unchanged
Cost of Capital
the return that is required by investors and is based on the risk of the firm’s cash flows
Cost of Equity
quantitative method used for predicting the price of a company’s stock based on the theory that its present-day price is worth the sum of all of its future dividend payments when discounted back to their present value. It attempts to calculate the fair value of a stock irrespective of the prevailing market conditions and takes into consideration the dividend payout factors and the market expected returns.
DDM Dividend Discount Model
3 valuation metrics for paying dividends
average sales growth for the past 5 years exceeds 10%
debt to equity ratio must not exceed one
profit margin must exceed 20%
True/False
The SML model is the same as the CAPM
True
Drawbacks
Only works if the firm pays dividends
If dividend growth is not consistent it may not be applicable
estimated cost of equity is very sensitive to the firm’s estimated growth rate
risk is not specifically considered
DDM Model Drawbacks
refers to the equity return based on market risk
Re (SML equation)
cost of debt, or the required return on a company’s debt
Rd
Corporations receive a ______ _______ on the interest paid on debt, this reduces their after tax cost of debt
Tax Break
what is received by the investor if all promised coupon payments are made, the bond is held to maturity and the par value is returned at maturity
Yield to Maturity
True/ False
There is no tax break for the frim on their preferred stock
True
minimum return a company need to earn to satisfy all its investors, including stockholders, bondholders, and preferred stockholders.
ALSO
The rate of return a firm earns on its existing assets to maintain the current value of its stock
WACC
individuals and institutional investors can purchase securities. the securities are initially sold by the managing investment bank firm. The issuing frim never actually meets the ultimate purchaser of securities.
Public Offering
securities are offered and sold to a limited number of investors
private placement
a company’s first equity issue made available to the public
IPO
a new equity issue of securities by a company that has previously issued securities to the public; sale of additional shares by a company whose shares are already publicly traded.
Seasoned equity offering
market in which new issues of securities are sold to initial buyers. The only time the issuing firm ever gets any money for the securities
“The Frim is Selling” is this type of market transaction
Primary Market (initial issue)
market in which previously issued securities are traded. The issuing corporation does not get any money for stocks traded on this market
investor A sells to investor B the FIRM DOESNT GET ANY MONEY
Secondary Market
a group of investment bankers or underwriters that market securities and share the risk associated with selling the issue; compensation comes from the spread
Price stabilization is an important component of the job for IPO offerings
Underwriting Syndicates
the difference between the underwriters buying price and the offering price; its the underwriters main source of compensation
Spread
means assuming the risk. money for securities is paid to the issuing frim before the securities are sold; there is a risk to investment banking
Underwriting
Once the securities are purchased from the issuing frim the are ____________ investors
distributed
issuing frim selects an investment banker to underwrite the issue. The frim and the investment banker negotiate the terms of the offer
often done under frim commitment where the underwriter buy the negotiated amounts of shares. The frim is paid for the full amount of the negotiated number of shares
Negotiated purchase “frim commitment”
several investment bankers bid for the right to underwrite the firms issue. The frim selects the investment banker offering the highest price
Competitive Bid
Issue is not underwritten, no money is paid, no risk for the investment bank
Investment bank attempts to sell the issue for a commission on each share actually sold. The investment bank only pay’s for what is actually sold.
Best Efforts
Investment banker helps market the new issue to a select group of investors, targets are current stockholders, employees, and/or customers
Privileged Subscription, or Rights Offering
prevents insiders from selling their shares for some period after the IPO (180 days). Can cause the stock price to drop right before the 180 day expiration
Agreement specifies how long insiders must wait after an IPO before they can sell some or all of their stock (180 is common but it can be shorter/longer)
Lockup agreements
a period of time around the IPO when company employees and the underwriters must limit communications with the public to “ordinary announcements and other purely factual matters”
done to prevent too much publicity and speculation in the hope of increasing demand for the stock
Quite Period
refers to raising money directly from prominent investors such as life insurance companies and pension funds. Can be done with or without investment bankers
Private Debt Placement
Advantages of private debt placement
Faster to raise money
reduces flotation cost
financial flexibility
NEGATIVES
High interest cost
restrictive covenants
possible future SEC registration
the listing of an initial public offering (IPO) below its market value, stock is considered to be ________ , demand will drive the price towards its intrinsic value
underpriced
For an IPO, this is the price at which a company or more commonly the underwriter sells its shares to its initial investors for
IPO
the price at which those begin to trade in the open market on that first day of trading
Opening price
the price at the end of the 1st day of trading
closing price
True/False
A reduction in the market rate of return would reduce market risk premium, reducing the cost of capital
True
TRUE
The cost of equity is NOT affected by the tax rate.
Dividends are NOT deductible
True
