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Corporate Finance > Term 1 > Flashcards

Term 1 Flashcards

1
Q

What is the main objective in CF?

A

Shareholder value maximisation

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2
Q

What is an activist investor?

A

Somebody who buys shares to influence board decisions

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3
Q

What are the three key issues of CF?

A

Investment Decisions
Finance Decisions
Dividend Decisions

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4
Q

Key issues of Investment Decisions?

A

Use NPV to value investments, take highest

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5
Q

Key issues of Financing Decisions

A

Can use retained earnings or external sources (equity v debt)

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6
Q

What are the key issues of dividend devisions?

A

Dividends are not a legal obligation, therefore should have a higher ROR than debt

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7
Q

What is BETA?

A

Measure of company risk, likelihood of dividend failure

Based on assumption markets are efficient

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8
Q

What is the current macroeconomic environment?

A

Brexit Uncertainty
Slowing Economic Growth
Rising Inflation
Volatile Currency

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9
Q

What are the three costs of the principal agent problem?

A

Monitoring expenditures by the principal- So principal can ensure that agent is working well
The bonding expenditures by the agent- A long term contract to show the agent is dedicated
Residual loss

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10
Q

How can you limit detrimental managerial behaviour?

A

Incentives
Monitoring
Internal Control Mechanisms
External Control Mechanisms

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11
Q

What determins a firms share price?

A

Value of the company

Dividends

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12
Q

How to you calculate the future value of a sum?

A

FV=Sum(1+i)^n

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13
Q

How do you calculate the Present value of a future value?

A

Future Value / (1+i)^n

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14
Q

What are the financial returns to a shareholder?

A

Dividends

Growth of share price

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15
Q

How do you calculate a share price?

A

P0=(D1+P1)/1+ke

Ke is discount rate

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16
Q

What are the sources of uncertainty when calculating financial returns?

A

Difficult in estimating dividends

Difficult to calculate cost of capital

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17
Q

How do you calculate dividend yeild?

A

D1/P0

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18
Q

How do you calculate Capital gains yeild?

A

P1-P0/P0

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19
Q

How do you calculate Total Return?

A

Div Yeild + Capital Gains Yeild

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20
Q

How do you calculate a share price if held for multiple years?

A

P0=D1/1+Ke + D2+P2/(1+Ke)^2…

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21
Q

How do you calculate the price for constant dividends?

A

P0=D1/Ke-g
G is dividend growth
Can be manipulated to determine cost of capital

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22
Q

How do you calculate the share price for non constant dividends?

A

P=D1/1+Ke + D2/(1+Ke)^2 + D3/(1+Ke)^3 +(D4/Ke-G)/(1+ke)^4

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23
Q

What are home made dividends?

A

Selling a portion of your shares to provide the dividends if they are withheld

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24
Q

How do you calculate the yield on a bond?

A

CY=NI/P

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25
Q

How do you calculate the YTM/Price of a bond?

A

PB= C[(1-(1/(1+i)^n))/i) +FaceValue/(1+i)^n

C=Annual interest Payment

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26
Q

What is the fisher sepeartion theorem?

A

Seperation of investment and consumption decisions raises consumer utility

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27
Q

What are the assumptions of FST?

A

Outcomes of investment are certainty
No transactions costs or taxes
Decision relates to one period only
Y0 income is received at the beginning of the period and Y1 income at end
MU of consumption is positive
MU of consumption is decreasing as consumption increases

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28
Q

What is C0 and C1

A

C0 is consumption at begining
C1 is at end
C1=Y1+I0(1+rI)

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29
Q

Discuss the IR method for FST?

A

The IR declines as more is invested, for that extra amount:
First 100 = 10%
Second 100 = 9%

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30
Q

How do you calculate wealth in P0 and P1

A

W0=Y+Y1/1+r

W1=W0(1+r)

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31
Q

What is the slope of the Financial Market Line?

A

-(1+r)

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32
Q

What is the optimum point of consumption with the Financial market line

A

Where it is tangential to an IC

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33
Q

What is the optimum point with all 3 Lines drawn?

A

Where the Production opportunity set is tangential to financial market line

34
Q

Name some forms of capital expenditure?

A

Expansion of business
Development of new business
Replacement of machinery
R&D

35
Q

What is the process of capital budgeting?

A 
Planning
Estimating
Evaluating
Selecting
Implementing
Post-Auditing
36
Q

What is the difference between in-dependant and mutually exclusive projects?

A

Independent - Cash flows to not impact on other project

Mutually Exclusive - Accepting one may prevents others

37
Q

What is payback period:

A

Time required to recoup initial investment
Benefits: Simple and easy to use
Disadvantages
Does not consider profitability

38
Q

What is the Accounting ROR?

A

Average rate of profit:

AverageProfit/Inital Invesment

39
Q

What is NPV?

A

CF/(1+r)^t-I

Cash flow from each period, discounted

40
Q

What is IRR?

A

Set NPV =0

Can be multiple IRR, Unconventional cash flows can cause issues, therefore must use incremental cash flow

41
Q

How do you use incremental cash flows

A

Take project B away from project A
This gives the NPV is switching from A to B
If positive, B is the better project

42
Q

What else can cause issues with IRR?

A

If you have unconventional cash flows, rely on NPV

43
Q

How do you ration capital

A

Calculate B/C by dividing NPV by Initial Invesment
Rank them in order
Assume all projects are divisible

44
Q

How do yo calculate Real Interest Rate?

A

RIR=(1+NIR)/(1+INF)-1

45
Q

What are the two types of capital rationing?

A

Hard - Has problems raising funds

Soft - Internal constraints to prevent investment

46
Q

What is a sensitivity analyisis?

A

Calculate NPV in a positive, negative and middle ground mindset
Then change key variables and see how they are altered

47
Q

What are modern approaches to risk ananalysis?

A 
Maximin
Maximax
Bayes - Laplace
Hurwicz
Minimax Regret
48
Q

What is a maxi-min approach

A

Consider worst possible outcomes and choose the best

49
Q

What is Maximax

A

Consider best possible outcomes and choose the best

50
Q

What is Bayes - Laplace?

A

Average payoffs across all states, take best, assume all probabilities equal

51
Q

What is Hurwicz criterion?

A

A weighted average of Maximax and Minimax
Weights are a and 1-a
If A =1, maximin outcome

52
Q

What is Minimax Regret?

A

This approach penalises for wrong decisions

If P1 is chosen, but N2 occurs, the opportunity cost is the forgone payoff of N2

53
Q

How do you calculate returns to an asset?

A

Rt=Pt/Pt-1 -1

54
Q

How do you calculate returns to an assset adjusting for Dividends?

A

R=(Pt-Pt-1)/Pt-1 + DT/Pt-1

R=Capital Yeild + Dividend Yield

55
Q

How do you calcualte average return on a stock?

A

Sum the values and divide by the number

56
Q

How do you calculate the variance of risk?

A

Sum (X-MeanX)^2/T-1

57
Q

How do you choose between investments, the easy way?

A

If same risk, choose higher returns

If same returns, choose lower risk

58
Q

What is unsystematic risk?

A

Unique Risk, associated with particular assets

Can be diversified

59
Q

What is systematic Risk

A

Unique Risk, effects all assets

Cannot be diversified away

60
Q

What is the market portfolio?

A

The portfolio that maximises diversification thus minimising risk

61
Q

How do you calculate Expected Return on a portfolio?

A

Weight multiplied by return

62
Q

How do you calculate the covarience of a portfolio?

A

Sum(Ri-ERi)(Rj-ERj)/T-1

63
Q

How do you calculate correlation coefficent?

A

Corr=Cov/SDiSDj
1=No Risk Reduction
-1=Max Risk Reduction

64
Q

How do you calculate the portfolio Variance?

A

X^2VarX1 +X^2VarX2+ 2XXCov

Remember Cov=CorrSDxSDY

65
Q

What is the efficiency boundary?

A

A line which will be chosen by an efficient investor, as it maximises returns

66
Q

If you have a risk free asset, what happens to the portfolio?

A

Constant Return, no risk

Variance(P) becomes Variance of X1 times weight

67
Q

What is the slope of a Risky-Risk free Portfolio Line?

A

E(RA)-RF/SDA

68
Q

What is the optimum combination of a risky-risk free portfolio, the marker portfolio?

A

A point of tangent between the risk free line and the efficient portfolio

69
Q

Can an investor borrow to invest?

A

Any point on the line after the tangent point will need to be borrowed to achieve

70
Q

What are the characteristics of the market portfolio?

A

Represents maximum diversification

Exists on capital market line

71
Q

What is the expected return on the market portfolio?

A

ER = Rf+[E(Rm-Rf)/SDRm]SDRi

Lamda = E(Rm-Rf)/SDRm
Market price of risk

72
Q

What does diversification look like when plotted on a graph?

A

1/x, assymptope at bottom is systematic risk

73
Q

What determined the level of systematic risk faced by a firm?

A

Sensitivity of revenues to economic activity
Degree of cost senstivity
Gearing - More Debt = more Risk

74
Q

An investor will only be rewarded for taking which type of risk?

A

Systematic

75
Q

What are the assumptions of CAPM?

A

Investors are risk averse and utility maximises
Perfect Competition
Single rate of interest
All assets perfectly divisible

76
Q

What is the CAPM expression?

A

Er=Rf+ (E(Rm)-Rf)Cov(i,m)/VarM

(E(Rm)-Rf) = Market risk premium

Cov/Variance referes to how the asset is related to the market

77
Q

What is BETA?

A

Measure of risk = Cov(i,m)/VarM

78
Q

How can you calculate correlation coefficient?

A

B=P*SDi/SDM

P=Correlation coefficient between market and i

79
Q

Why do all assets return to SML line?

A

If ROR is above equilibrium, investors invest and price rises, causing ROR to fall

80
Q

How does BETA relate to an assets ROR relative to the market

A

BETA>1 means an asset is more volatile than the makrket

Corporate Finance (2 decks)

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