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FIN 701 LSUS > Module 5 > Flashcards

Module 5 Flashcards

1
Q

represents the funds used to finance a firm’s assets and operations

A

Capital

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2
Q

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

A

Cost of Capital

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3
Q

how the market views the RISK of the firms assets and how they are used

A

Cost of Capital

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4
Q

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

A

Weighted Average Cost of Capital (WACC)

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5
Q

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

A

Cost of Capital

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6
Q

the return that is required by investors and is based on the risk of the firm’s cash flows

A

Cost of Equity

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7
Q

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.

A

DDM Dividend Discount Model

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8
Q

3 valuation metrics for paying dividends

A

average sales growth for the past 5 years exceeds 10%
debt to equity ratio must not exceed one
profit margin must exceed 20%

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9
Q

True/False

The SML model is the same as the CAPM

A

True

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10
Q

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

A

DDM Model Drawbacks

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11
Q

refers to the equity return based on market risk

A

Re (SML equation)

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12
Q

cost of debt, or the required return on a company’s debt

A

Rd

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13
Q

Corporations receive a ______ _______ on the interest paid on debt, this reduces their after tax cost of debt

A

Tax Break

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14
Q

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

A

Yield to Maturity

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15
Q

True/ False

There is no tax break for the frim on their preferred stock

A

True

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16
Q

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

A

WACC

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17
Q

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.

A

Public Offering

18
Q

securities are offered and sold to a limited number of investors

A

private placement

19
Q

a company’s first equity issue made available to the public

A

IPO

20
Q

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.

A

Seasoned equity offering

21
Q

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

A

Primary Market (initial issue)

22
Q

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

A

Secondary Market

23
Q

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

A

Underwriting Syndicates

24
Q

the difference between the underwriters buying price and the offering price; its the underwriters main source of compensation

A

Spread

25
Q

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

A

Underwriting

26
Q

Once the securities are purchased from the issuing frim the are ____________ investors

A

distributed

27
Q

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

A

Negotiated purchase “frim commitment”

28
Q

several investment bankers bid for the right to underwrite the firms issue. The frim selects the investment banker offering the highest price

A

Competitive Bid

29
Q

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.

A

Best Efforts

30
Q

Investment banker helps market the new issue to a select group of investors, targets are current stockholders, employees, and/or customers

A

Privileged Subscription, or Rights Offering

31
Q

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)

A

Lockup agreements

32
Q

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

A

Quite Period

33
Q

refers to raising money directly from prominent investors such as life insurance companies and pension funds. Can be done with or without investment bankers

A

Private Debt Placement

34
Q

Advantages of private debt placement

A

Faster to raise money
reduces flotation cost
financial flexibility

NEGATIVES
High interest cost
restrictive covenants
possible future SEC registration

35
Q

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

A

underpriced

36
Q

For an IPO, this is the price at which a company or more commonly the underwriter sells its shares to its initial investors for

A

IPO

37
Q

the price at which those begin to trade in the open market on that first day of trading

A

Opening price

38
Q

the price at the end of the 1st day of trading

A

closing price

39
Q

True/False

A reduction in the market rate of return would reduce market risk premium, reducing the cost of capital

A

True

40
Q

TRUE
The cost of equity is NOT affected by the tax rate.
Dividends are NOT deductible

A

True

FIN 701 LSUS (3 decks)

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