SS 11. Corporate Finance Flashcards
What is the equation for the calculation of the cost of equity, using the bond yield plus risk premium approach?
Yield to maturity on outstanding long-term debt + Subjective risk premium
Cannibalization is:
A situation where the introduction of a new product will affect the sales of existing projects.
A debt financed share buy-back will be most likely to enhance earnings per share when:
The earnings yield exceeds the after tax cost of debt
When a new project reduces the cash flows of an existing project of the same firm, it is best described as a(n):
Externality
Higher receivables turnover is an indicator of (better/worse) liquidity
better
Receivables are converted into cash more rapidly
List 3 committees that must be composed of independent directors:
Compensation
Nominating
Audit
(Also the 3 most important)
Payables Payment Period =
(Payables/Purchases) * 365
The optimal capital budget for a firm is best described as occurring when the company’s marginal cost of capital is:
equal to the investment opportunity schedule.
Which kind of voting system is the most supportive of shareholder protection?
Cumulative voting
SRI Policy stands for:
Socially Responsible Investment Policy
Cash Conversion Cycle =
Operating Cycle - Days of payables
or
Days of inventory + days of receivables - days of payables
List 3 sources of short-term financing used by smaller companies:
collateralized loans
factoring
loans from non-bank companies
How should board members be selected as per best practice?
Elected on an annual basis
Weighted Average Cost of Capital (WACC) =
WdRd(1-t) + WcRc + WpRp
When is capital budgeting for incremental cashflows most likely to be a simple process?
When capital availability is unlimited
Degree of Operating Leverage (DOL):
%change in operating income / %change in units sold
Q(P-V)
/
Q(P-V) - F
Operating Cycle =
Days of inventory + days of receivables
A drag on liquidity is caused by:
receiving cash slower than expected
What are on the x and y axis for the NPV profile?
x: discount rate
y: NPV
The dividend chronology is best described as follows:
Declaration date, ex-dividend date, holder of record date and payment date
Which motive for holding inventory might reflect fears about rising inflation?
Speculative
If a company has a strong view on the cost of an input, it may buy more or less than warranted by its production schedule or customer demand
6 Key Principles of the Capital Budgeting Process:
- Decisions are based on after-tax cash flows, not accounting income
- Cash flows are based on opportunity cost
- The timing of cash flows is important
- Cash flows are analyzed on an after-tax basis.
- Financing costs are reflected in the project’s required rate of return and should not be considered. Sunk costs are already expensed, so should not be considered.
- Consider the loss of revenue / profitability due to cannibalization.
Average Inventory Processing Period =
(Inventory/COGS) * 365
Sovereign Yield Spread =
Sovereign Yield Spread = Bond Yield - Risk-free rate
Break point formula:
Break point =
Amount of capital at which the source cost of capital changes
/
Target weight of new capital raised from the source
‘The extent to which fixed-income securities are used in a firm’s capital structure’ defines:
Financial Leverage
The percentage mix of debt, preferred stock, and common equity that maximizes a firm’s stock price is known as the:
Target (optimal) capital structure
What is most likely to be the typical maturity of Bankers acceptances?
30-180 days
Name the two types of poison pill:
Flip-in
Flip-over
Earnings Yield is the inverse of:
P/E
E/P
‘Shareholders being entitled to sell their shares back to the company at fair market value, following a transaction that does not meet their interests’ describes:
Dissenters’ Rights
How would you be most likely to estimate the beta for a project or a private company?
Identify the asset beta, then adjust for leverage
Quick Ratio =
Current assets - inventories
/
Current liabilites
Asset Turnover Ratio =
Revenue (sales)
/
Total Assets
Receivables turnover =
Net annual sales / average receivable
Present Value of a Perpuity =
PMT / I
Cash Ratio =
Cash + Cash equivalents
/
Current Liabilities
Break even quantity =
Q =
Fixed costs / (price - variable cost)
FC / (P - V)
Bond Equivalent Yield (BEY) =
[(Par value - purchase price)/purchase price] * (365/Days to maturity)
Best for comparing short term bonds
Using WACC is not appropriate if a project:
has a different risk level than the overall firm.
In this case the analyst should calculate a risk-adjusted WACC, using the project risk or project beta.
Money Market Yield (MMY) =
[(Par value - purchase price)/purchase price] * (360/Days to maturity)
The MIRR assumes that cash flows from all projects are reinvested at ___ ___ __ _____ , while the IRR assumes that the cash flows from each project are reinvested at ___ _______ ___ ___.
the cost of capital
the project’s own IRR
Related party transactions should always be disclosed in:
Annual reports
Country Risk Premium =
Sovereign Yield Spread *
(Annualized standard equity index / annualized standard deviation of sovereign bond market in terms of the developed market currency)
Sovereign Yield Spread = Bond Yield - Risk-free rate
What is most likely to be the typical maturity of a bank sweep service?
One day
What are the 4 steps of the capital budgeting process?
- Idea generation
- Analyzing project proposals
- Creating the company-wide capital budget
- Monitoring decisions and conducting a post-audit
Days of Payables =
Accounts payable
/
(Purchases/365)
‘The target company repurchases shares from the bidding company at a large premium to the current share price in order to prevent the takeover’ desribes:
Greenmail
‘A share repurchase method where a company stipulates a range of acceptable prices and the same price is paid to all shareholders’ describes:
Dutch auction
A debt financed share buy-back will be most likely to enhance earnings per share when:
The earnings yield exceeds the after tax cost of debt
Business risk is associated with:
Sales
Input and Output prices
Demand
Competition
Company’s ability to adjust to a downturn, which is measured as a percentage of (fixed expenses/total expenses)
SRI Policy stands for:
Socially Responsible Investment Policy
If book value of equity is less than market value of equity, then book value per share will _____ after a share repurchase.
Decrease
What is the most accurate arrangement of the difference components of capital structure, starting from the cheapest to most expensive?
Debt
Preferred Stock
Common Stock
For WACC, component cost of preferred stock =
Preferred dividend
/
(Par price - floatation cost)
The effectiveness and performance of a board of directors should be reviewed:
Annually
Net annual sales / Average receivables =
Receivables turnover
‘Directors receive large severance/compensation packages in the event of a takeover’ describes
Golden Parachutes
What are the 2 main purposes of the post-audit process?
To improve the forecasting capacity of the firm
To improve the operations of the firm
If BVPS was less than market price per share before a share repurchase, then BVPS will:
Decrease
‘Business risk’ is the risk associated with operating earnings; it is comprised of:
sales risk and operating risk.
What are on the x and y axis for the NPV profile?
x: discount rate
y: NPV
Unlevered Beta =
Beta
/
1 + [ (1 - t) * (D/E) ]
‘A share repurchase method where a company stipulates a range of acceptable prices and the same price is paid to all shareholders’ describes:
Dutch auction
A pull on liquidity involves:
paying out cash faster than expected.
Breakeven Quantity =
Fixed costs / (price - variable cost)
Q = FC / (P - V)
Name 3 methods used to estimate a company’s cost of retained earnings
CAPM
DCF method
Bond yield plus risk premium
A drag on liquidity is caused by:
receiving cash slower than expected
Given two mutually exclusive projects with normal cash flows, the point at which their net present value profiles intersect the horizontal axis is most likely the projects’:
internal rate of return.
Degree of Financial Leverage =
DOF =
Q(P - V) - FC
/
Q(P - V) - FC - I
(DTL = DOL * DFL)
Degree of total leverage
= % change in EPS / % change in sales
= degree of operating leverage * degree of financial leverage
Current Ratio =
Current Assets
/
Current Liabilities
The estimated cost of debt of a company is the ________ of its last bond issue adjusted by the tax savings
Yield to Maturity
NOT COUPON RATE
Average Collection Period =
(Accounts Receivable / Sales) * 365
Name 4 methods of aligning managers’ interests with shareholders:
- Managerial compensation
- Intervention of shareholders
- Threat of takeover
- Threat of firing
Put these strategies in order of risk: Laddering, Matching, Mismatching.
Mismatching
A mismatching strategy is the riskiest strategy and requires accurate and reliable cash forecasts.
Laddering
A laddering strategy is a compromise solution, where some assets match liability maturities and others have longer maturities designed to pick up extra yields
Matching
The estimated cost of debt of a company is the ________ of its last bond issue adjusted by the tax savings
Yield to Maturity
NOT COUPON RATE
Inventory Turnover Ratio =
COGS
/
Inventory
____ _____ should be ignored for capital budgeting purposes.
Sunk costs
‘The discount rate at which the PV of a project’s cost is equal to the PV of the sum of the future values of the cash inflows, compounded at the firm’s cost of capital’ is the:
Modified IRR
List 3 things independent board members should not be/do:
Independent board members should not be current or former employees of the company
Independent board members should not serve as or be affiliated with advisors (including external auditors) to the company or its senior management
Independent board members should not do business with the company
