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Finance Markets > Week 5-10 > Flashcards

Week 5-10 Flashcards

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1
Q

Acquisition

A

When one company takes over another company

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2
Q

Merger

A

Combination of two companies of similar size to form a new company

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3
Q

Operation synergies

A

When the value of the two combining firms is greater than the separate sum of their individual parts (Vab - (Va +Vb))

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4
Q

Financial bidder

A

Acquirer attracted to the takeover because of the potential return of selling the target in a few years

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5
Q

Strategic bidder

A

Acquirer attracted to the takeover due to the potential strategic fit of the two companies - improve operations

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6
Q

Motivations for M&A’s

A

Economies of scale
Economies of vertical integration
Market power
Diversification
Earning per share growth

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7
Q

Difference between strategic and financial bidders

A

Payment method
Motivations

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8
Q

Deal premium

A

The difference between the stand alone market value and the higher deal price

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9
Q

Tender offer

A

A public offer by one firm to directly buy the shares of another firm

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10
Q

Hostile bid

A

An offer directly to shareholders, which threatens to initiate a proxy fight to remove company directors unless they negotiate

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11
Q

Proxy fight

A

Attempt to gain control of the firm by supporting a sufficient number of shareholder votes to replace management

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12
Q

Efficient market hypothesis

A

An efficient capital market is one in which share prices immediately and fully reflect available information. No one can beat the market.

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13
Q

Implications of efficient capital management

A

Normal rate of return
Firm receives fair value

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14
Q

Assumptions of EMH (3)

A

Investors are rational
Independent deviations from rationality
Arbitrage

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15
Q

Weak form

A

Todays share price reflects all the data of past prices so investors cannot predict price fluctuations

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16
Q

Semi strong vs strong market efficiency

A

Semi strong incorporates public information and strong markets use all information and insiders cannot make abnormal return

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17
Q

Behavioural finance view on rationality (2)

A

Investors are not rational
Do not diversify

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18
Q

Behavioural finance view on independent deviations(2)

A

People draw conclusions from insufficient data
People are conservative and too slow to react

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19
Q

Behavioural finance view on arbitrage

A

Few professionals cannot offset many small investors

20
Q

Evidence supporting behavioural finance view on market efficiency (4)

A

Earnings surprise
Size effect
Value versus growth effect
Bubbles

21
Q

Net present value

A

The difference between the present value of cash inflows and the present value of cash outflows over a period of time

22
Q

Cost of capital/required return

A

How much the firm must earn from an investment to compensate the investors for the use of capital to finance the project

23
Q

Cost of equity

A

The return that equity investors require on their investment in the firm

24
Q

Cost of debt

A

The return that lenders require on the firms debt

25
Q

Dividend growth model

A

Cost of equity = (dividend in next period/current share price) + dividend growth rate

26
Q

SML approach

A

Return on equity = risk free rate + systematic risk coefficient * (market risk premium)

27
Q

Advantages/disadvantages of dividend growth model

A

Simplicity
But doesn’t account for risk
Growth rate unlikely to be constant

28
Q

Advantages of SML (2)

A

Adjusts for risk
Applicable even when you don’t have steady dividend growth

29
Q

Disadvantages of SML

A

Difficult to work out market risk premium and systematic risk
Difficult to predict the future

30
Q

Systematic risk

A

Cannot be eliminated by diversifying

31
Q

Weighted average cost of capital

A

The minimum return a firm needs to satisfy investors

32
Q

WACC proper definition

A

The weighted average of the cost of equity and the after-tax cost of debt

33
Q

Two approaches for expanding into new industry

A

SML - use beta coefficient for the new industry
Divisional cost of capital - calculate WACC for each division of a large corporation

34
Q

Unlevered firm

A

Financed by only equity

35
Q

MM proposition I (perfect market)

A

Value of levered firm = value of unlevered firm

Change in capital structure doesn’t change value of the firm

36
Q

MM proposition II

A

Cost of equity for leveraged firm has a positive linear correlation with debt-equity ratio (more debt = higher Re)

37
Q

Increasing debt in MM proposition II

A

Shareholders ask for more compensation for bearing higher risk - cost of equity increases

38
Q

Why will WACC be unchanged if debt-equity ratio changes

A

Cost of debt will be offset by effect of the change in the cost of equity

39
Q

Key assumptions to MM propositions (3)

A

Individuals can borrow as cheap as corporations
No taxes
No transaction costs

40
Q

Tax and debt

A

The tax paid on interest rates on debt is tax deductible, so debt financing will result in higher market value

41
Q

Debt-equity ratio and taxes

A

Firms can raise their total cash flow for substituting equity for debt
Debt = tax shield

42
Q

Value of unlevered firm (taxes)

A

Cash flow/cost of capital

43
Q

MM Proposition I (taxes)

A

Value of levered firm = value of unlevered firm + present value of tax shield

44
Q

Dangers of debt

A

Bankruptcy costs - direct(legal/administrative)
Indirect - borrow money at high int rate

45
Q

Cost of capital - debt - taxes

A

Issuing more debt will increase total cash flows and so lowers risk and cost of capital

46
Q

How firms decide debt-equity ratio(3)

A

Taxes
Type of assets
Uncertainty of income

Finance Markets (2 decks)

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