Study Session 8 - Corporate Finance Flashcards
What is the formula to determine the amount of the Initial Investment Outlay for a new investment(project)?
= FCInv + NWCInv
FCInv = includes purchase price, shipping & installation
NWCInv = ∆non-cash current assets - ∆non-debt current liabilities
How do you calculate the After-tax operating cash flow (CF)?
Sales
- Cash Operating Expenses
- Depreciation
=Operating Income before taxes
-Taxes on Operating Income
=Operating Income After Taxes
+Depreciation
=After Tax Operating Cash Flow
or
CF = (S - C - D)(1-T) + D
How do you calculate the Terminal year after-tax non-operating cash flow (TNOCF) ?
TNOCF= SalT +NWCInv-T(SalT -BT)
SalT = cash proceeds from sale of fixed capital
BT = book value of fixed capital
T = marginal tax rate
How is the annuity figure actually calculated using the EAA approach?
Simple, just plug number into the TVM calc
N = # of yrs of the project
I = required return of the project
PV = negative amount of the already calculated NPV
PMT = this is what we are solving for!!!!
FV = 0
What is Economic Income?
equal to the after-tax cash flow plus the change in the investment’s market value.
**interest is ignored and is instead included as a component of the discount rate
economic income = after-tax cash flow + (ending mv - beginning mv)
What are the 2 key factors that account for the differences between economic and accounting income?
- Accounting depreciation is based on the original cost of the investment, while economic depreciation is based on the change in market value of the investment
- The after-tax cost of debt (interest expense) is subtracted from net income, while financing costs for determining economic income are reflected in the discount rate.
What is Depreciable basis ?
is equal to the purchase price plus any shipping or handling and installation costs.
What is NOPAT & how is it calculated?
Net _O_perating _P_rofit _A_fter _T_ax
= EBIT * ( 1 - T )
What is Economic Profit and how do you calculate it?
EP is a periodic measure of profit above and beyond the dollar cost of the capital invested in the project. The dollar cost of capital is the dollar return that the company must make on the project in order to pay the debt holders and the equity holders their respective required rates of return
EP = NOPAT - $WACC
NOPAT = Net operating Profit After tax , aka EBIT*(1-T)
$WACC = dollar cost of capital * capital
What is** Residual Income** and how is it calculated?
Residual income focuses on returns on equity
As such:
RI = Net Income - equity charge
Equity Charge = required return on equity * beginning period book value of equity
How do you calculate Net Working Capital Investment (NWCInv)?
NWCInv = ∆non-cash current assets - ∆non-debt current liabilities
What is the objective of a company’s capital structure decision?
To determine the optimal proportion of debt and equity financing that will minimize the firm’s WACC
**This will maximize the value of the firm.
Explain MM Proposition I (No Taxes) …..
Capital structure is irrelevant; the value of the firm is unaffected by the capital structure
VL = VU
Explain MM Proposition II (No Taxes) ……
The cost of equity increases linearly as a company increases its proportion of debt financing.
The benefits from using more debt are exactly offset by a rise in the cost of equity, resulting in no change to a firm’s WACC
Explain MM Proposition I (With Taxes) …..
Value is maximized at 100% debt, the tax shield provided by debt causes the WACC to decline as leverage increases.
VL = VU + (t * d)
How do you calculate the change in stock price when the stock goes from with dividend to ex-dividend?
