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Corporate Finance > Term 2 > Flashcards

Term 2 Flashcards

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
Q

What are the three approaches of company valuation?

A

Accounting Information:
Stock Market Values
Discounted Cash Flows

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26
Q

Discuss accounting information

A

Financial, P/E and P/B Ratios

This is called relative valuation

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27
Q

What are the advantages and disadvantages of accounting information

A

Information is easily available and adjustable

Fundamentally backwards looking
Can be manipulated

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28
Q

Discuss Stock market values

A

Market Cap:
Price*Number of shares
Requires EMH assumption

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29
Q

What are the advantages and disadvantages of Stock Market Valuation

A

Data is easy to obtain
Allows relative comparisons

Are markets efficient
Quality of information

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30
Q

Discuss discounted cash flows

A

Most Popular Method

Requires a lot of assumptions and information

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31
Q

How do you perform a discounted cash flow valuation?

A

Sum(D/1+ket)

32
Q

What are the two components of systematic risk of equity?

A

No debt:
Business of operating risk
Re=RF+BRP

Debt:
Financial Risk
Re=RF+BRP+FRP

33
Q

How do you estimate the cost of equity for WACC?

A

Ke=Rf+B(ERm-Rf)

34
Q

What are the problems with estimating the cost of equity?

A

Different corporations have different levels of systematic risk
Effected by time horizon
Can be problematic if many tranches of debt

35
Q

What is Gordons Dividend Model?

A

V=FCF/WACC-g

Free cash flow
G is growth of FCF

36
Q

How do you exectue the dividend cash flow valuation?

A

Forecast FCF

Determine the WACC

Estimate Continuing Value

Assess the Value of Equity

Test the Results

37
Q

How do you calculate FCF?

A

FCF=EBIT(1-Tc)+Deprecation - Net Investment - Increases in working capital

Net Investment = Capital Expenditures - Depreciation

38
Q

How do you calculate the WACC with tax?

A

k=Ke(E/V)+kd(D/V)(1-Tc)

39
Q

How do you calculate the systematic risk of assets?

A

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
Q

What factors effect valuation?

A

Acquisitions
Management buy outs
New Issues
Liquidations

41
Q

What is the key issue of Dividend Policy?

A

Pay out and the frequency
Cash or Share Repurcahase
Regular or Sepcial
Needs of Investor

42
Q

Types of Dividends

A

Special Dividends - One off
Stock Dividend - More Shares
BuyBacks

43
Q

What are the two theories on dividiends?

A

Traditional - More Dividends = Higher Value

MM - Dividend policy irrelevant

44
Q

What occurs to the dividend policy if the market has imperfections?

A

Policy becomes relevant to value

45
Q

What happens if taxation is present?

A

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
Q

What are the advantages of share repurchase?

A

Provides investers with more choice

Flexibility to firm

Dividend Tax avoidance

Increase control

47
Q

Why do firms pay dividends?

A

Despite all disadvantages:

Clientelle effect
Signalling
Agency Problem

48
Q

Define Clientelle Effect?

A

Firms choose dividend polict based on tax rates of investors

49
Q

How can investors be divided under the clientelle model?

A

High Tax - Prefer no dividends

Low Tax:
Individual - Low Dividends for Income
Institutional - Prefer Dividends for income
Corporations - High Dividends

50
Q

What is the issue of the clientelle effect?

A

There are enough high paying dividend firms to satisfy investors, thus no boost to be gained

51
Q

What is signalling?

A

Dividend reflect managers beliefs
Can be reversed, high dividends = Lack of opportunities

Also dividend smoothing

52
Q

Discuss agency costs?

A

Dividends can prevent managers from using excess cash inefficently

53
Q

What is some empricial evidence on dividends?

A

Dividends are being replaced by BuyBacks
Dividend Smoothing Exists
High Tax Brackets = More Dividends

54
Q

Define Merger

A

A transaction where two firms agree to integrate options

55
Q

Define Acquisition

A

A stratergy where one firm buys 100% of another firm

56
Q

Defien takeover

A

A acquisition where the target firm did not solicit the bid

57
Q

What are the three types of mergers?

A

Horizontal
Vertical
Conglomerate

58
Q

Who are the gainers and looses of mergers?

A

The target firm gains

The acquirer looses out

59
Q

Discuss the acquisition premium

A

Acquirers pay an average premium of 43% over true value

60
Q

Discuss the Key Steps of a Merger?

A 
Valuation
Public Offer
Hostile V Friendly
Methods of Payment
Tax Issues
Approval
61
Q

Discuss Hostile V Friendly?

A

If proposed to managers and they agree - Friendly

If Resisted, submit tender offer - Hostile

62
Q

Discuss cash v stock?

A

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
Q

Discuss Tax issues?

A

If paid in cash, instant tax liability

If in shares, defered

64
Q

Who must the deal be approved by?

A

Both sets of managers

UK Regulator

65
Q

What are the reasons for Mergers?

A

Economies of Scale, Scope and VI
Efficiency Gains
Diversifcation

66
Q

problems with Mergers?

A

EPS and Tax motives do not work

Multiple different perspectives to be considers

67
Q

To what parties are mergers beneficial?

A 
Not always underperforming companies
Better for society
Acquirer bad
Target Good
Employees Lose
Directors loose
Finanical Institutions win
68
Q

How do you analyse a merger using short term event studies?

A

Calculate abnormal returns within the time window for each day through:
Ra=R-E(R)
Calculate Statistical Significance

69
Q

Why do the targets earn higher returns?

A

Acquirers bids to higher price
Loss of Control
Loss of Potential Gains
Competition

70
Q

What is the hubris hypothesis?

A

The winning firm will over bid,

Market is efficent, but bidders make mistakes

71
Q

What are the Antitakeover Defences?

A 
Poison Pill
White Knight Defence
Shark Repellents
Greenmail
Supermajority Amendments
Golden Parachutes
72
Q

What is a posion pill?

A

Target shareholders given right to sell at discounted prices

73
Q

What is a white knight defence?

A

Managment calls upon a friendly investor to intervene

74
Q

What is a shark repellents

A

Amendments to corporate charter to make it more difficult

75
Q

What is a greenmail

A

Buying off the shares

76
Q

What is a supermajority amendments

A

Making it require a large approval to go ahead

77
Q

What are golden parachutes

A

Illegal large termination bonuses for execuitves

Corporate Finance (2 decks)

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