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F3 > Section B > Flashcards

Section B Flashcards

1
Q

What is the view of the Tradionalist when considering Capital Structure and WACC

A
  • Introducing Debt will initially force WACC down
  • Eventually too much debt will increase Ke and WACC will rise
  • At extreme levels of Gearing (Capital Structure) the Kd will also rise and Lenders get worried
  • There is an optimal capital structure where the WACC is at a minimum
  • At point X the overall return required to investors is minimised
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2
Q

What is the view of M&M 1958 on capital structure and WACC

A
  • Without Tax
  • Value of geared and ungeared company will be the same as long as similar operationg risks
  • Investors are indifferent to Personal or Corporate gearing
  • WACC will not change (Neither will value of entity) with different Capital Structure
  • Value of entity stems solely from Post-Tax (Before financing) operating income
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3
Q

What is the view of M&M 1963 on capital structure and WACC

A
  • With TAX
  • Geared entity has an advantage as they pay less TAX and therefore value of entity will be higher with lower WACC
  • In the presence of TAX the downward force is stronger than upward force
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4
Q

What are M&M Key Assumptions

A
  • Investors are indifferent to personal or coroprate gearing
  • C/o does not pay TAX
  • Market is strongly efficient
  • Investors can borrow at same rate as company (Interest Rate)
  • Kd remains constant @ all levels
  • No Trans costs
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5
Q

What are the rules for Thin Capitalisation

A
  • Interest part that a 3rd party would lend is tax deductible
  • Excess is disallowed
  • The borrowing capacity of the individual company and its subsidaries are considered (but not the rest of the group)
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6
Q

Explain M&M Dividend Irrelevancy Theory and assumptions

A

Dividend decison is irrelevant. As long as company continues to invest in positive NPV projects the wealth of S/H will increase

  • No Tax
  • No Trans costs
  • Return is in two parts (Cap Gain or Div) so irrelevant how it gets returned
  • S/H can manufacture their own Div policy buy selling shares (Note: This will reduce their influence on the company)
  • Return is determined by the systematic risk and therefore Div decision does not affect risk nor return
  • Share price is affected by Div payment
  • S/H wealth will stay the same with a div payment
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7
Q

Explain Clientele effect

A

Investors should only invest if they agree with Dividend policy of entity.

The Div Policy is not important but as long as they continue with SAME policy is what is important

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8
Q

What are the 2 Strong signalling effects

A
  • Reduction in DPS = Entity is going through financial difficulty
  • Failure to payout = Close to receivership
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9
Q

What are the different Dividend Policies

A
  • Stable
    • Ideal of Instituional Investors
    • And Mature business
    • Careful if earnings decrease this can still be maintained
  • Constant Payout ratio
    • Volatile earnings
  • Residual
    • Only paid out if no other positive NPV projects to onvest in
    • Growth Phase
  • Zero policy
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10
Q

What is a Ratchet Policy when it comes to Div policy

A

Paying out a stable but rising DPS

  • Div lags behind earnings so not to reduce when earnings drop
  • No tax change to investor as it is kept constant
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11
Q

Explain Scrip Dividends

A

S/H are given more shares instead of cash dividend

  • Share Price, DPS & EPS will fall as more shares in issue
  • Investor saves on brokerage fee while reinvesting
  • S/H wealth stays the same
  • Capital Structure and Gearing remain the same
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12
Q

Explain Share Repurchase vs one-off large Dividend

A
  • Both have same impact on Cash position and gearing (reduce equity and therefore increaase Gearing)
  • Impact on S/H value stays the same for both
  • Cash reduces Share price (equity is reduced) while Share Repurchase reduces number of shares in issue
  • One-off payout as a certain value but S/h may be dissapointed if it does not continue
  • Share repurchase - S/h can choose whether to sell or not
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13
Q

Tax implications for Mergers. How and when is group relief available

A
  • Group relief is only available for losses and profits generated AFTER they have joined the group
  • Group relief ceases once arrangements are made to seel shares
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14
Q

What are the reasons behind a spin off

A
  • MGMT structure is clearer
  • May avoid takeover bid
  • Identify true value of a division hidden in bit entity
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15
Q

What are some of the conditions are MBO’s and Venture Capialists

A
  • Usually around 5 to 10 years
  • Mix of debt and equity
  • Convertible shares are common
  • Usually memeber on the board
  • Exit strategy agreed at the start
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16
Q

Under MBO’s what is the ranking of financial structues

A
  • Providers of Senior Debt will have first ranking over all assets and capital
  • Junior debt sits between Senior and Oridinary S/H - usually provided in the form of mezzaine finance. Can be in the form of a mix between debt and convertible debt
17
Q

What are the possible PRE-BID defences

A
  • Posion Pill - Giv S/h right for convertibles should a bid be recieved by certain date
  • Stakeholder Communication
  • Revaluation of NCA - makes entity more expensive
  • Changes to Article of Association - require higher % of voting for a T/o to be allowed
18
Q

What are the POST-BID defensive tactics

A
  • Appeal to S/H - show them future prospects so they will want to hold on to stake
  • Appeal to authorities to say it will not be good for market
  • Make a counter bid (Pacman)
  • Obtain a White Knight - last case scenario
  • Attack the bidder - The way they manage, EPS calculation, A/c policies
19
Q

When the form of cash consideration for a takeover what are the Advantages and DisAdv (Bidder and Biddee)

A

Advantages

  • Bidder - Will usually result in a lower price and costs due to cash is a known price and less risk
  • Biddee - Increase the S/H liquidity and less risky than share exchange

DisAdv

  • Bidder - May require finance and therefore increase greaing (financial risk). S/H may not approve
  • Biddee - S/h will have no participation in new formed entity
  • Biddee - S/h may be subject to tax on shares sold for cash (this tax may not be immediate on share exchange)
20
Q

When the form of share exchange consideration for a takeover what are the Advantages and DisAdv (Bidder and Biddee)

A

Adv

  • Bidder - No cash needs to be raised so gearing will not increase
  • Bidder - Can Bootstrap EPS if they have higher P/e ratio
  • Biddee - S/h capital increased and therefore gearing improved. S/h of the acquired company become part of new entity
  • Share exchange can be used to finance large acquisitions

DisAdv

  • Price Risk - Share price may fall once becomes public which may make bid fail
  • Bidder - S/h will have to share profits with those of the new entity
21
Q

When offering cash for consideration what are the implication to be considered for a Debt or Rights Issue offer

A

Debt

  • Gearing will increase (financial risk) so S/h may not be happy
  • Debt is cheaper than equity
  • May have exisitng covenants about debt ratio

Rights Issue

  • Will dilute EPS for S/h
  • S/h must have cash to buy new shares
  • Gearing will fall
22
Q

What is the process for evaluating a share exchange?

A
  • Value Bidder as independant (Share Price)
  • Value Biddee
  • Value of Synergy
  • Total Value of Combined Co
  • Then value number of shares post integration
  • No of shares in Bidder
  • No of shares issued to biddee
  • Value of combined / Total No. of new share in issue
23
Q

What are Drukers 5 golden rules when we look at post-acq integration

A
  1. Cross entity promotion must be done within 1 year
  2. Top line MGMT across the board must be in place within 1 year
  3. Treat all of the new entities Stakeholders with respect
  4. ‘Common core of unity’ must be shared between both for synergies
  5. Acquirer must think ‘what can we offer them’ (not what can they do for us)
24
Q

What are the post-acq enhancing strategies to be considered

A
  • Intergration Strategy must be in place before
  • Entities CoC must be in re-evaluated
  • Risk diversification may reduce the CoC and therefore increase the value of the entity
  • Risks of the acquisition need to be evaluated
  • Identy EOS and Synergies
  • Consdier effect on wortkforce
  • Review each unit for cost savings or potetnial asset disposals as they may be more valuable if sold to another entity
25
Q

What are some reasons for Divestment

A
  • Individual parts are greater value than combined
  • Under performing division
  • Strategicg change onto core competences
  • Response to crisis
  • Sell off - for defensive reasons
26
Q

Explain the role of venture capitalists

A
  • Only provide up to 50% (so MGMT can retain controlling interest)
  • Usually for up to ten years
  • Expect Annual returns of 25% +
  • Can be mix of debt and equity
  • Convertible Preference Shares given
27
Q

Revaluation of assets can be seen as conflict of interest during the MBO negotiation period as it will have an impact on the consideration paid

Asset Stripping, Competition reduction and Big data Ops are all reasons why Aqcuistion will benefit S/H Wealth (Diversification is not as its better done by investors than companies)

A

F3 (7 decks)

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