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Corporate Finance
Level 2 CFA Corporate Finance
57
Finance
Post-Graduate
04/13/2013

Additional Finance Flashcards

 


 

Cards

Term
The repurchase of 20% of a firm’s outstanding common shares will cause free cash flow to the firm (FCFF) to:
Definition

REMAIN THE SAME.

 

Share repurchases are a use of free cash flows, not a source. FCFF is cash flow that is available to all capital suppliers. Notice the conspicuous absence of repurchases in the following: FCFF = CFO + Int (1 – tax rate) – FCInv.

Term
Effect of increased expected inflation on WACC
Definition

Increases WACC

 

Required rates of return on investments generally exceed inflation. An increase in expected inflation will generally increase the required return on equity and debt; therefore, the WACC will rise as inflation rises.

Term

(High/low) indicates greatest capacity to pay back debts:

(1) Acid-test ratio

(2) Debt capitalization ratio

(3) Interest coverage ratio

Definition

(1) HIGH acid-test

(2) LOW debt capitalization

(3) HIGH interest coverage

Term
Acid-test ratio
Definition

The acid-test ratio is:

(current assets - inventory) / current liabilities

 

A higher acid-test ratio indicates greater capacity to pay principal and interest.

Term
Interest coverage ratio
Definition

EBIT / annual interest expense

 

A higher interest coverage ratio indicates greater capacity to pay principal and interest. 

Term
In an efficient market, required rate of return for a mutual fund is equivalent to its _______
Definition
IRR
Term

Litigation-related valuations may be required for (4 things):

Definition

shareholder suits, damage claims, lost profits claims, or divorce settlements

Term

A bankruptcy proceeding is an example of a _______-related valuation for a private company.

Definition

transaction-related valuation

Term

FISA was an act written and passed by Calisto’s legislative body. This is a:

Definition
statute
Term

When a firm acquires another firm and its earnings per share increase, even though there are no economic gains from the merger, this is called:

Definition

Bootstrapping

Term

Residual income models work for companies with: 

Definition

No dividends and volatile or negative cash flows. They do not work, however, when the clean surplus relation does not hold, as is the case when companies take charges against equity.

Term

Strategic policy risk:

Definition

the risk that managers may enter into transactions or incur other business risks that would not be in the best long-term interests of shareholders, but would result in large payoffs for managers or directors

Term

The country risk rating model:

Definition

determines a risk premium for an emerging market

Term
Short-term profitability is determined by:
Definition

supply and demand

Term
Formula for growth rate g
Definition

g = r − [B0(ROE − r)] / (V0 − B0)

r = cost of equity

B0 = book value per share

V0 = stock price

Term

A merger arbitrage or risk arbitrage strategy:

(1) is considered a _________ strategy:

(2) will experience a loss if ________.

(3) involves purchasing the stock of the _____ company and shorting the stock of the ______ company

Definition

(1) “short volatility” strategy:

(2) will experience a loss if the expected merger is cancelled

(3) involves purchasing the stock of the target company and shorting the stock of the acquiring company

Term
Horizontal merger
Definition

A combination of two firms in the same line of business 

Term

The industry lifestyle stages during which firms often merge to gain access to additional capital are the (2):

Definition

(1) pioneer/development stage

(2) rapid growth stage

Term

Conglomerate mergers are least likely for companies in which stages of the industry lifecycle (2)?

Definition
Mature growth, stabilization
Term
Equity carveout -- what is it? How shares issued?
Definition

In an equity carve-out, the intent is to establish a new, independent firm. Therefore, the parent company usually does not maintain a controlling interest in the new firm.

 

Shares usually issued in a public offering

 

 

Term

Steps involved in valuation using comparable transaction analysis (3 steps):

Definition

(1) Identify recent takeovers of comparable companies

(2) Calculate relative value measures

(3) Apply relative value measures to target firm

Term

The three broad value categories (intervals) for the post-merger competitiveness of an industry, based upon the HHI index are:

Definition

less than 1000 (competitive)

between 1000 and 1800 (moderately concentrated)

greater than 1800 (highly concentrated)

Term

A corporate code of ethics should articulate ______ of an organization and should be included ______.

Definition

(1) the values, responsibilities, and ethical conduct of an organization

 

(2) statement of governance policies

Term

A statement of director’s oversight, monitoring, and review responsibilities should include information regarding:

Definition

internal controls, risk management, accounting disclosure, compliance, nominations, and compensation awards.

Term

The valuation process consists of 5 steps:

Definition

 

 

  1. Understanding the business. 
  2. Forecasting company performance. 
  3. Selecting a valuation model. 
  4. Complete the valuation. 
  5. Decision making.

 

Term

Global best practice states:

(1) % of directors that should be independent

(2) frequency of directors elections

(3) concurrent service of board members on other boards

Definition

(1) 75% of board members to be independent

(2) all directors elected annually

(3) board members do not serve on more than 2-3 boards total

Term

Information asymmetry signaliing theory

Definition

Signaling theory results from asymmetric information, which refers to the fact that managers have more information about a company’s future prospects than the firm’s owners and creditors.

 

Since managers are reluctant to sell new stock if they think the stock is undervalued, but very willing to sell stock if they think the stock is overvalued, selling stock sends a negative signal about a firm’s future prospects.

Term

Pecking order theory:

Definition

suggests that managers choose methods of financing based on the visibility of signals they send. Raising equity is the least preferred method of financing under pecking order theory, and it sends a negative signal

Term

HHI:

If post-merger HHI is less than ____, the industry is considered competitive and an antitrust challenge is unlikely.

 

A post-merger HHI value between ___ and ___ will place the industry in the moderately concentrated category.

 

If the change is greater than ____ points, the merger is likely to be challenged on antitrust grounds.

 

A post-merger HHI calculation greater than ____implies a highly concentrated industry. In this case, if the change is greater than ____ the merger is likely to be challenged.

Definition

Less than 1,000,

 

1,000 and 1,800

If the change is greater than 100 points

 

A post-merger HHI calculation greater than 1,800

 

change is greater than 50

Term

The value of a conglomerate derived using a sum-of-the-parts valuation is the (2 terms):

Definition
break-up value; private market value
Term
Responsibilities of board of directors (3):
Definition

(1) hiring the firm’s CEO and

(2) determining the CEO’s compensation

(3) establishing corporate values and governance structures to ensure that business is conducted in an ethical, fair, and professional manner

Term

Audit committee best practices:

(1) Internal audit staff of firm should _____

 

(2) ______ members should have relevant financial experience

 

(3) Should have an annual meeting with _____ and _____ should not be present

Definition

(1) report directly to the audit committee. The other statements are not consistent with best practices. On the audit committee

 

(2) two or more members

 

(3) with auditors, management should NOT be present

Term
In order to safeguard their interests, minority shareholders will often seek an analyst's opinion of the value of the firm. This opinion is referred to as a:
Definition
Fairness opinion
Term

Timing options:

Definition

allow a company to delay an investment with the hope of having better information in the future.

 

Delaying an investment and basing the decision on the better information gained by waiting may improve the NPV of the overall project.

Term
Corporate governance is defined as:
Definition

the system of principles, policies, procedures, and clearly defined responsibilities and accountabilities used by stakeholders to overcome conflicts of interest inherent in the corporate form. 

Term

In the stabilization phase, firm growth is ____

 

In the decline phase, firm growth is _____

Definition

approximately the same rate as the overall economy

 

negative

Term

 

Important considerations of the issuer’s character include (6): 

Definition

strategic direction

financial philosophy

conservatism

track record

succession planning

control systems

Term

Takeover defenses:

White knight / white squire / black knight / grey knight

Definition

Black knight = hostile takeover

 

White knight = friendly/majority investor to stop takeover

 

White squire = friendly/minority investor to stop takeover

 

Grey knight = 2nd bidder after black knight, not necessarily good or bad

Term
After-tax operating cash flow (formula):
Definition
ATOCF = [(Sales - Cash Operating Expenses)x(1-t)] + [Depreciation*tax rate]
Term
After-tax non-operating cash flow (TNOCF)
Definition

=Sell PriceT + NWCInv(recoverable) - Tax Rate*(Sell PriceT - BT)

 

BT = Book Value at time T = Initial Capital investment - accumulated depreciation

Term
Capital budgeting replacement adjustment (as opposed to expansion)
Definition

Reduce initial outlay by current after-tax salvage value of old assets

 

Incremental depreciation is change in depth

Term
Comparing projects with unequal lives (+formula)
Definition

Least common multiple of lives

 

Equivalent annual annuity (EAA): annuity equal to PV of project CFs

 

EAA(CF) = r*(NPV) / [1-(1+r)-n]

 

r = rate per period

Term
Economic profit (formula)
Definition

EP = Net Income - Equity Charge

Equity Charge = (equity capital * ke)

Term
Economic Profit (EP)
Definition

= EBIT*(1-t) - WACC*Capital

=NOPAT - $WACC

 

Capital = Investment = Capital investment required + additional working capital

 

Consulting fees are SUNK COSTS

Term
Economic Income (formula):
Definition

EI = ATCF - Economic Depreciation

 

ED = (MVBeg - MVEnd)

Term
Two main differences between economic income and accounting income:
Definition

(1) Accounting depreciation is based on the original cost of the investment, while economic depreciation is based on the change in MV of the investment

 

(2) 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

Term

Capital Structure Theory

(1) MM Prop I (no taxes)

(2) MM Prop II (no taxes)

(3) MM Prop I (with taxes)

(4) MM Prop II (with taxes)

Definition

(1) Capital structure irrelevant; VL = VU

 

(2) The cost of equity increases linearly as company increases proportion of debt financing. No change in WACC.

 

(3) Value is maximized at 100% debt; tax shield provided by debt causes WACC to decline as leverage increases

 

(4) WACC minimized at 100% debt; tax shield causes WACC to decline as leverage increases

Term

(1) Miller/Modigliani dividend theory

 

(2)Dividend preference theory

 

(3) Tax aversion theory

Definition

(1) In no-tax/no-fee world, dividend policy is irrelevant. Homemade dividends.

 

(2) Investors prefer the certainty of current cash to future capital gains

 

(3) Investors are tax averse to dividends; prefer companies buy back shares

Term
Change in Stock price when it goes ex-dividend:
Definition

Delta(P) = D(1-TD) / (1-TCG)

 

 

Term
Target Payout Dividend Adjustment Model (+ when used)
Definition

Used when company earnings expected to increase and current payout ratio is below target payout ratio.

 

Expected Dividend = D0(prev) + [(Expected Increase in EPS)*(Target Payout Ratio)*(Adjustment Factor)]

Term

(1) Dividend Coverage Ratio

 

(2) FCFE Coverage Ratio

Definition

(1) Net income / Dividends

 

(2) FCFE / (Dividends + Share Repurchases)

Term

Dividend Policies:

(1) Residual dividend

(2) Longer-term residual dividend

(3) Dividend stability

(4) Target payout ratio

Definition

(1) D based on earnings less funds retained to finance capital budget

 

(2) Forecast capital budget, smooth dividend payout

 

(3) Dividend growth aligned with sustainable growth rate

 

(4) Long-term payout ratio target

Term

(1) Value of Acquirer post-merger

 

(2) Gains for target shareholders

 

(3) Gains for acquirer shareholders

Definition

(1) VAT = VA(Pre) + VT(Pre) + Synergies - Cash paid to target firm shareholders

 

(2) Takeover Premium (TP) = PPaid for shares  - VPre-Merger


(3) Synergies - TP = S - (PT - VT)

Term

Effective Tax Rate on Dividends:

(1) Double taxation/split rate systems

(2) Imputation system

Definition

(1) Effective Rate = Corp. Rate + (1-Corp. Rate)(Indv. Rate)

 

(2) Eff rate = shareholder's individual tax rate

Term

Adjusting cost of equity for leverage

+formula to account for costs of financial distress

Definition

re = r0 + (r0 – kd) (1 – t) (D/E)

 

re = r0 + (t*D) - PV(costs of financial distress)

 

r0 = cost of equity for unlevered firm

Term
WACC (alternative formula):
Definition
[MVDebt/(MVDebt+MVEquity)] * kd(1-t) + [MVequity/(MVequity+MVdebt)]*ke
Term
Adjusted Multiple
Definition
(Raw Multiple)*[(1+(CP/(1+D/E))]
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