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All Kmowldege Flashcards

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1
Q

3 decisions of investment managers

A

Investment principle

Capital structure principle (financing)

Dividend principle

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2
Q

Managers 4 objectives to deal with

A

Shareholders
Bond holders
Society
Financial markets

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3
Q

Managers vs shareholders

A

T: shareholders have complete control over management
R: they use AGM and board of Directors to control management and reduce the separation of ownerships an agency issues. But in reality these methods are not very effective

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4
Q

Managers vs bond holders

A

T. No conflict of interest
P. Bond holders want them to take less risky projects to ensure they receive there payment back

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5
Q

Managers vs financial markets

A

T. Managers releases info all on time, and are rewarded for doing so, in order for the true value of the firm to be evaluated. Short term gimmicky accounting trick do not work and will be punished

P. Managers do withhold information and release it when it is most suitable to the firm, market inefficiencies and asymmetric information

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6
Q

Managers vs society

A

T. All social costs and benefits can be traced back to the firm

P. In reality this is not the case and firm can cause damage and good and not be recognised
Environmental costs - water pollution, dirty energy
Social benefit- increased access points, development, employment in shit areas

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7
Q

NPV

A

Accept project if NPV is positive

Use expected future cash flows and discount them

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8
Q

IRR

A

Accept if IRR is greater than the cost of capital if project

IRR determined when NPV is equal to zero

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9
Q

IRR good

A

IRR is unaffected by scale so good for comparison as it’s a percentage

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10
Q

Why is higher NPV despite having lower IRR

A

Due to growth rate, main cash flows are relatively delayed

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11
Q

IRR failures

A

No IRR at all if NPV always positive or negative

If benefits occur before the cost then NPV is increasing as a function of discount rate

Multiple IRR, if cash flow signs change more than once

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12
Q

Profitability index good

A

If projects scalable then choose project with highest PI and scale project to exhaust BC

If there budget constraint where firm can either do one or the other then, they choose project with highest NPV

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13
Q

PI bad

A

If resources aren’t fully exhausted via PI then choose projects which result in highest NPV

Multiple resource constraints can cause PI ranking to break down

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14
Q

When is deprictiation relevant for cash flows

A

Reduces the taxable profit of the firm

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15
Q

Cannibalism

A

New project affects the sales of a previous project

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16
Q

Opportunity cost s

A

Resources used to generate cash flows if project wasn’t taken

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17
Q

3 ways to analyse projects

A

Break even analysis

Sensitivity analysis

Scenario analysis

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18
Q

Break even analysis

A

Levels where NPV equals zero

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19
Q

Sensitivity analysis

A

Determining what may happen given some shocks and how the NPV may change if assumptions are dropped

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20
Q

Scenario analysis

A

Calculation of probably outcomes based sensitivity analysis

Objective probabilities or subjective probabilities

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21
Q

Cost of capital

A

Weighted average of equity and debt cost

Increases with increased risk

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22
Q

Cost of debt

A

What firm pays on long term borrowing

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23
Q

Cost of equity

A

What investors expect return to be

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24
Q

Investment risk

A

Systematic and unsystematic risk

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25
Company risk
Business risk - faced by all equity holders of companies (unstable economy = increased business risk) Financial risk- only faced by equity holders in leveraged firms (due to d financing being more risky)
26
Security market line (above/ below)
Stock above line then it has excessive return and is undervalued Stock below line, smaller return and over valued
27
Why is debt holder risk less than equity holders
Debt holders are first to be paid in event of bankruptcy
28
Intrinsic value
Gain/loss that would be made today is option exercise today
29
Equity as option
Equity can be thought of as a call option With strike price equal to value of debt
30
What happens if firms assets is less than total debt
Then firm doesn’t have money to pay shareholders so stock price goes to zero and firm goes bankrupt
31
Types of real options
Option to delay - value if underlying variable are trending in favourable direction Expand - value if demand is greater than expected Abandon - value if demand is less than expected
32
Payoff for abandon option
Value of liquidating assets - value from continuing
33
Payoff from delayed option
Value of project exceeds value of delay
34
BSM comparison
Needs 5 inputs Restrictive assumptions
35
Binomial tree model comparison
Less restrictive, can alter for early exercise or changing volatility Have to estimate prices at each branch Lot of information required
36
Patent real option
Gives you the right to produce something not the obligation If value of project greater than cost of converting into a product is positive then develop
37
Value of firm
Discounted future cash flows
38
MM1
Value of firm is independent of capital structure
39
MM assumptions
No taxes Effecient markets No transaction costs Cost less arbitrage ops Rational investors No agency issues No bankruptcy costs Price of assets equal to their PV of future cash flows
40
MM2
Debt plus equity equals firms assets Cost of levered equity is equal to unlevered cost of equity plus a premium proportional to the debt to equity ratio of firm
41
Factors that do affect cap structure
Financial distress Taxes Transaction costs Agency issues Asymmetric info
42
Trade off theory
Increasing debt can increase tax shield however his comes at cost of increasing financial dirstress Firms have difficulty repaying debt leading to bankruptcy
43
Financial distress cost a
Direct , bankruptcy, legal admin fees, sale of assets under their actual value Indirect. Impact operations, struggle to raise capital for firm, supply chain becomes uncertain of your position and stops supplying in case they don’t get paid, customers stop buying if they believe they won’t get their warranty
44
Pecking order theory
Retained earning s Debt Equity
45
Signal of equity issue
Signals that they are selling over valued stocks so resulting in average price drop of 3 percent. Bad signal to investors but also suggests that there are profitable opportunities out there
46
Debt signal
No signal with debt
47
Pecking order theory assumptions
Managers act in interests of shareholders Asymmetric information about true value of firm between public and management
48
Cap structure in practice
Most uk companies have high debt equity ratios Different firms tend to have different ratios Some similarities in ratios if same industry, age, product, size, growth prospects
49
Dividend dates
Declaration date Ex dividend date Record date Payable date
50
How do firms pay dividend
Cash Stock split issue dividends in the form of shares not cash
51
Reasons for stock repurchase
Want to change debt to equity ratio Other way of paying dividend to potentially reduce tax paid by investor So they can provide shares if employees exercise their options
52
Types of stock repurchase
Open market Dutch auction Tender offer Green mail Targeted
53
Dividend irrelevancy policy
Perfect capital markets and holding investment policy fixed, dividend Policy is irrelevant and does not affect initial share price If firms want to increase dividend then they have to issue shares to finance it
54
Bird in hand
Investors are naturally risk averse and would rather the certainty of a dividend than the uncertainty of capital gains so prefer increased dividends Firms with increased dividends usually higher in value
55
Clientele effect
When the dividend policy of a firm attempt to match that of the preferences of their investors. High taxed individuals want buyback but low taxed individuals want dividends
56
Percentages of types of investor
Individual 52% , prefer buy back Institutional - 47% no preference Corporations -1% dividends
57
Drips.
Dividend reinvestment plans Allow investors to use their dividends to purchase equity in the firm at a discounted rate, usually 2-10% Good for firm as they can determine tax preference of investors. Also if they have struggle raising capital. As those who don’t need regular income would opt for DRIP instead
58
Signalling effects
Under asymmetric info , Investors assume changes in dividend policy reflect the firms anticipated future earnings
59
Examples of signals
Increase dividend - increased confidence. Smooth payout Special dividends If they reduce dividends, produce adequate information on why. Target dividend policy on long run expected earnings not short run
60
Merger
When two firms usually of similar size come together to form a new entity, each set of shareholders must agree to this
61
Acquisition
When one firm usually larger decides to buy another firm l this is paid for in cash or stocks
62
Conglomerate acquisition
Where firm acquires another in a completely seperate industry to their own Tesla twitter EBay PayPal Do this to potentially be able to access different markets ( financial) Leads to economies in provision of company wide services like head office administration Also potentially results in firm learning operation of the other which can improve overall operations
63
Vertical m and a
Where firm decides to purchase a different part of the supply chain IKEA and Baltic forests Means they have more supply chain control and cost management
64
Horizontal m and a
When one firms purchases firm in same industry as itself Disney and 21st century fox - Do this to increase market power and reduce competition, all other firms also benefit from reduced competition Economies of scale, Market power Synergies
65
Main motive for m and a
Managers be,I’ve they can further maximise value of firm through this process Value release, usually due to poor management, firm is undervalued and with merger true value can be recognised Value creation From the combination of the two firms means additional value can be created called synergies
66
Causes of synergy
Revenue enhancement Cost reductions Lower cap requirements Lower taxes
67
Revenue enhancement
Marketing gains; Increased advertising, Increased distribution network More product mix Strategic benefits Increased network Increased development Increased market power
68
Cost reductions
More efficient company Asset can be reallocated to where they are needed Departments can merge and fire employees Expertise transfer Economies of scale and
69
Lower tax
Increased debt capacity and can use losing divisions to offset taxes
70
Other motives for m and a
Diversification of income stream s Asset allocations Debt capacity and lower borrowing costs Increase liquidity Managerial motives and added status by managing larger firm Earnings growth
71
Takeover defenses general
Poison pill Golden parachute
72
Pre bid takeover defense
Improve operational effeiciency Good investor relations Staggered board. Third up for election each year and need two thirds for majority, ensure acquirer must win votes two years in a row before they have control
73
Post bid defense
Reject initial bid to show confidence Recapitalisation, increase dividends to shareholders or buyback shares, this reduces cash in firm so less attractive, also raise share price so cost of acquisition is higher Sell assets so firm less attractive White knight , friendly investor White squire , passive investor with special voting rights
74
Proxy fight
Acquiring firm attempts to use proxy votes in order to dethrone the board to put its own board members in to assist with hostile takeover
75
Why bids fail
High financial adviser fees Asymmetric info between firms Lack of integration between firm High costs and over paying Over confidence of the manger and its expected cash flows
76
IPO
Shares of a company are issued to the public for the first time.
77
Mechanisms of IPO
Underwriter/syndicate Sec filings Valuations Pricing and risk management
78
How ipo done
Primary secondary Dutch auction Firm commitment Best effort
79
Largest ipo
Glencore international
80
CSR
When firms go beyond their interest to appear to be doing some social good which is required by law, work with employees p, families , local communities to improve quality of life.
81
How to measure CsR
Index Money spent
82
Example of CSR index
FTSE4GOOD INDEX Focuses on ESG DOW JINES SUSTAINABILITY INDEX
83
Traditional behaviour of Corp finance
Investors and consumers are rational Max value
84
Modern behavioural view CF
They are bias
85
Psychological biases
Excessive optimism Better than average Confirmation bias Illusion control
86
Where can managerial overconfidence play into
Investment decisions - accept negative NPV projects Dividend policy - retain earnings for bad projects and decrease value of firm Cap structure - too much debt leading to financial distress

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