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Corporate Finance > Term 2 > Flashcards

Term 2 Flashcards

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1
Q

What does an efficent market do?

A

Provide correct signals to financial managers
Encourage the purchase of shares
Ensure efficient allocation of resources

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2
Q

What are the three forms of EMH?

A

Weak - Reflect Past info
Semi-Strong - Reflect Past and publicly available
Strong - Reflect Past, Public and Private

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3
Q

What are the implications of EMH?

A

As information is freely and immediately available
Prices will adjust instantly
No opportunity for excess returns
Firms cannot fool investors,
Will always receive a fair price for their shares

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4
Q

What is implied if analysts are making money?

A

If technical analysts make money - weak inefficient
If Fundamental analysts make money - semi-strong inefficient
If insider traders make money - strong inefficent

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5
Q

What are the implications of EMH for financial decision making?

A

Use passive investment strategy

Do not consider timing for equity release

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6
Q

What are some calendar anomalies?

A

Calendar Effects

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7
Q

What are the two theories on capital structure?

A

Traditional: There is an optimal structure

Modigliani and Miller (MM) capital structure is irrelevant

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8
Q

How do you calculate the value of a firm?

A

V=E+D
Value
Value of Equity
Value of Debt

Sum Earnings/(1+K)^t

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9
Q

How do you calculate Weighted Average Cost of Capital

A

k=Ke(E/V)+kd(D/V)

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10
Q

What is the traditional view with no taxation

A

Firms can substitute to from equity to debt, increasing risk but lowering average cost of capital

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11
Q

What is the MM view with no taxation?

A

Argues the traditional view will fail, as substitution will cause the ROR on equity to rise

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12
Q

What are the assumptions of MM?

A

Market value is independent of capital structure

The expected ROR on stock increases in proportion to the debt equity ratio

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13
Q

What is the cost of debt capital if taxes are included?

A

Kd(1-Tc)

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14
Q

What is a tax shield?

A

TcD

The saving the firm makes by paying tax deductible interest

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15
Q

What level of earnings will shareholders receive in a taxed firm?

A

(EBIT-KdD)(1-Tc)

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16
Q

What is the value of levered firm?

A

Vl=Vu+Dtc
Levered
Unlevered
Tax times debt

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17
Q

How can the value of a levered firm be expressed interms of personal tax?

A

Vl=Vu+(1-(1-Tc)(1-Ts)/(1-Tb))B

Ts is tax on equity income
TB is tax on bond income

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18
Q

Discuss bankruptcy and its costs

A

A high debt-equity ratio increases the risk of bankruptcy

Direct Costs - Cash outflows

Indirect- Arise before firm fails, consumers stopping buying

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19
Q

What are the implications of the trade off theory?

A

Firms with:
volatile cash flows
Intangible assets
Long life products

Will have less debt

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20
Q

What are the limitations of trade off theory?

A

It rules out conservative debt ratios for taxed firms - Opposite empirically

Positive association with profitability and debt

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21
Q

Discuss asymmetric information and signalling?

A

Managers can use a rise in debt ratios to signal all is well

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22
Q

What is the simple view of a firm?

A

Assets:
Existing Investments generating cash flows
Future Investments

Liabilities:
Debt
Equity

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23
Q

Discuss the par value of debt?

A

Par value is issue value

If IR fall, market value > par value

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24
Q

What is the value of a firm?

A

Where assets = liabilities

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25
What are the three approaches of company valuation?
Accounting Information: Stock Market Values Discounted Cash Flows
26
Discuss accounting information
Financial, P/E and P/B Ratios | This is called relative valuation
27
What are the advantages and disadvantages of accounting information
Information is easily available and adjustable Fundamentally backwards looking Can be manipulated
28
Discuss Stock market values
Market Cap: Price*Number of shares Requires EMH assumption
29
What are the advantages and disadvantages of Stock Market Valuation
Data is easy to obtain Allows relative comparisons Are markets efficient Quality of information
30
Discuss discounted cash flows
Most Popular Method | Requires a lot of assumptions and information
31
How do you perform a discounted cash flow valuation?
Sum(D/1+ket)
32
What are the two components of systematic risk of equity?
No debt: Business of operating risk Re=RF+BRP Debt: Financial Risk Re=RF+BRP+FRP
33
How do you estimate the cost of equity for WACC?
Ke=Rf+B(ERm-Rf)
34
What are the problems with estimating the cost of equity?
Different corporations have different levels of systematic risk Effected by time horizon Can be problematic if many tranches of debt
35
What is Gordons Dividend Model?
V=FCF/WACC-g Free cash flow G is growth of FCF
36
How do you exectue the dividend cash flow valuation?
Forecast FCF Determine the WACC Estimate Continuing Value Assess the Value of Equity Test the Results
37
How do you calculate FCF?
FCF=EBIT(1-Tc)+Deprecation - Net Investment - Increases in working capital Net Investment = Capital Expenditures - Depreciation
38
How do you calculate the WACC with tax?
k=Ke(E/V)+kd(D/V)(1-Tc)
39
How do you calculate the systematic risk of assets?
BA=(D/D+E)BD+(E/D+E)BE Systematic risk of assets, BA Systematic risk of equity, BE Systematic risk of debt, BD
40
What factors effect valuation?
Acquisitions Management buy outs New Issues Liquidations
41
What is the key issue of Dividend Policy?
Pay out and the frequency Cash or Share Repurcahase Regular or Sepcial Needs of Investor
42
Types of Dividends
Special Dividends - One off Stock Dividend - More Shares BuyBacks
43
What are the two theories on dividiends?
Traditional - More Dividends = Higher Value | MM - Dividend policy irrelevant
44
What occurs to the dividend policy if the market has imperfections?
Policy becomes relevant to value
45
What happens if taxation is present?
If personal taxes are incldued, firms should retain all income as CG it taxed at a lower value Firm value falls if dividends paid
46
What are the advantages of share repurchase?
Provides investers with more choice Flexibility to firm Dividend Tax avoidance Increase control
47
Why do firms pay dividends?
Despite all disadvantages: Clientelle effect Signalling Agency Problem
48
Define Clientelle Effect?
Firms choose dividend polict based on tax rates of investors
49
How can investors be divided under the clientelle model?
High Tax - Prefer no dividends Low Tax: Individual - Low Dividends for Income Institutional - Prefer Dividends for income Corporations - High Dividends
50
What is the issue of the clientelle effect?
There are enough high paying dividend firms to satisfy investors, thus no boost to be gained
51
What is signalling?
Dividend reflect managers beliefs Can be reversed, high dividends = Lack of opportunities Also dividend smoothing
52
Discuss agency costs?
Dividends can prevent managers from using excess cash inefficently
53
What is some empricial evidence on dividends?
Dividends are being replaced by BuyBacks Dividend Smoothing Exists High Tax Brackets = More Dividends
54
Define Merger
A transaction where two firms agree to integrate options
55
Define Acquisition
A stratergy where one firm buys 100% of another firm
56
Defien takeover
A acquisition where the target firm did not solicit the bid
57
What are the three types of mergers?
Horizontal Vertical Conglomerate
58
Who are the gainers and looses of mergers?
The target firm gains | The acquirer looses out
59
Discuss the acquisition premium
Acquirers pay an average premium of 43% over true value
60
Discuss the Key Steps of a Merger?
``` Valuation Public Offer Hostile V Friendly Methods of Payment Tax Issues Approval ```
61
Discuss Hostile V Friendly?
If proposed to managers and they agree - Friendly If Resisted, submit tender offer - Hostile
62
Discuss cash v stock?
Cash is simple Stock is where firm issues stock to give to shareholders Exchange ratio is the number of shares recited for each share
63
Discuss Tax issues?
If paid in cash, instant tax liability | If in shares, defered
64
Who must the deal be approved by?
Both sets of managers | UK Regulator
65
What are the reasons for Mergers?
Economies of Scale, Scope and VI Efficiency Gains Diversifcation
66
problems with Mergers?
EPS and Tax motives do not work | Multiple different perspectives to be considers
67
To what parties are mergers beneficial?
``` Not always underperforming companies Better for society Acquirer bad Target Good Employees Lose Directors loose Finanical Institutions win ```
68
How do you analyse a merger using short term event studies?
Calculate abnormal returns within the time window for each day through: Ra=R-E(R) Calculate Statistical Significance
69
Why do the targets earn higher returns?
Acquirers bids to higher price Loss of Control Loss of Potential Gains Competition
70
What is the hubris hypothesis?
The winning firm will over bid, | Market is efficent, but bidders make mistakes
71
What are the Antitakeover Defences?
``` Poison Pill White Knight Defence Shark Repellents Greenmail Supermajority Amendments Golden Parachutes ```
72
What is a posion pill?
Target shareholders given right to sell at discounted prices
73
What is a white knight defence?
Managment calls upon a friendly investor to intervene
74
What is a shark repellents
Amendments to corporate charter to make it more difficult
75
What is a greenmail
Buying off the shares
76
What is a supermajority amendments
Making it require a large approval to go ahead
77
What are golden parachutes
Illegal large termination bonuses for execuitves

Corporate Finance (2 decks)

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