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Econ304 - Business Finance > Business Finance Definitions/ Long Question Answers > Flashcards

Business Finance Definitions/ Long Question Answers Flashcards

(55 cards)

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1
Q

Advantages of going public

A

Liquidity (larger investor pool of wider markets)

Better access to capital

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2
Q

Disadvantages of going public

A

Must satisfy all requirements of being a public company such as SEC Filings and listing requirements

Annual financial statements made public

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3
Q

What type of IPO do underwriters face the most risk?

A

Firm commitment IPO

Guarantee they will sell all the stock for offer price

Purchase entire stock for lower than offer price

If the issue does not sell at offer price, remaining shares sold at lower price

Underwriter bears loss

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4
Q

Describe a best efforts IPO?

A

Underwriter cannot guarantee that stock will be sold

Tries to sell stock at best price

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5
Q

Describe an auction IPO?

A

Underwriters let market determine price by auctioning off the company

Final price determined using bids

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6
Q

Describe the IPO puzzles of underpricing and cyclicality in IPO Issues

A

IPOs appear to be underpriced

Price at the end of trading on the first day is higher than IPO price

Number of issues is highly cyclical

Good Times = Market flooded with issues

Bad Times = Few number of issues

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7
Q

What is book building?

A

Customers inform underwriters of their interest by telling them the number of shares they want to purchase

Customers value their relationship with underwriters

Underwriters add up all the total demand and adjust price until its unlikely that the issue will fail

Process for coming up with the offer price is based on customer interest

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8
Q

Treasury Bills

A

Pure discount bonds

Maturities ranging from few days - 26 weeks

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9
Q

Treasury Notes

A

Semi annual coupon bonds

Maturities between 1-10 years

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10
Q

Treasury Bonds

A

Securities with maturity longer than 10 years

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11
Q

TIPS

A

Standard coupon bonds adjusted for inflation

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12
Q

What are the alternative sources from which private companies can raise equity capital?

A

Angel investors
VC Firms
Private Equity firms
Corporate Investors

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13
Q

Advantages of Private company raising money from a corporate investor

A

Corporate partner provides capital, expertise, and access to distribution channels

Corporate partner may become an important customer for a start-up

Willingness of an established company to invest is an important endorsement

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14
Q

Disadvantages of private company raising money from a corporate investor?

A

Not all corporate investors are successful due to interference

Corporate investor can gain access to proprietary technology

Once young firm aligns with corporate partner, competitors of partner not willing to do business with private company in early stages

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15
Q

Main areas of corporate finance

A

M&A
Equity capital market
Debt capital market

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16
Q

Key Principles of Corporate Finance

A

Intra-company corp finance
Broader corp finance

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17
Q

Yield to Maturity

A

Discount rate that sets PV of promised bond payments equal to current market price of bond

IRR on a bond

Total rate of return that investors will earn on their invested money if they buy the bond at current price and hold until maturity

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18
Q

When a firm has no debt

A

Cost of unlevered equity increases

All equity financed

Cost of financing project without incurring debt

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19
Q

How can a bond have a negative yield?

A

Investor receives less interest payments and principal over duration of the bond.

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20
Q

Modigliani-Miller 1

A

Perfect capital markets
Value of firm not affected by capital structure
Value of unlevered firm = value of levered firm

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21
Q

Key Assumption of Modigliani-Miller 1

A

Operate in perfectly efficient markets
No taxes
No transaction costs
No brokerage fees
Firms lend/borrow at any risk rate

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22
Q

Explain how the YTM differs from annual coupon rate?

A

Investor makes a loss at maturity

If a bond selling at discount, price will be below FV

Bond selling at par has price which is equivalent to FV

Bond trading at discount against par would earn a return from receiving the annual coupon and the FV

YTM exceeds annual coupon rate

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23
Q

Advantage of Debt Financing

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A

Cheaper source of finance

Debt cost is lower

Offsets increase in equity cost

Interest expense is tax deductible

Reduced taxable income

24
Q

Modigliani-Miller 2

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A

Cost of capital of levered equity = cost of capital of unlevered equity

Premium is proportional to market value debt equity ratio

25
Explain the inverse relationship between price and YTM
When a bond's price increases, YTM falls When a bond's price falls, YTM increases When interest rates and yield increase, investors require a greater yield to invest Higher YTM reduces impact of PV of separate cash flows and price When interest rates and bond yields decrease, reduces discounting impact on cash flow, resulting in price hike.
26
When Debt to equity ratio increases
Cost of unlevered equity increases Cost of debt is constant Cost of debt increases above threshold Increases risk of insolvency
27
Value of firm with leverage
Made of interest paid to debt holders Made of income to equity holders Levered firm exceeds unlevered firm Due to present value of tax savings
28
How firms spend free cash flow
Retain & reinvest into new invest opportunities Retain in cash reserves Pay out to shareholders through dividend payout Share repurchase
29
Advantages of a rights offer?
New shares offered to existing shareholders Protects existing shareholders from underpricing Lower demand as shareholders are only a fraction of all existing shareholders Investors don't want to increase their percentage weight of stock in portfolios.
30
Tender offer
Purchase specific number of shares at prespecified price Occurs over 20 days If not enough shares, offer is cancelled No buyback occurs
31
Targeted Repurchase
Purchase shares from major shareholder Includes pension funds
32
How are merger waves caused
There is economic expansion Greater consumer confidence Markets are bullish Prices rise Opportunities to create shareholder value
33
What is a public debt offering?
Prospectus created with details of the offering Formal contract between bond issuer and trust company signed Trust company ensures terms of contract enforced
34
Advantages of Horizontal merger
When target & acquirer in same industry Cost reduction synergies Easier to layoff overlapping employees, parallel departments & terminate redundant resources Increases purchasing power between suppliers
35
What is a private offering?
No need for prospectus or formal contract Promissory note is enough Contract in private placement does not have to be standard
36
Why shouldn't managers acquire firms in different industries for diversification
Investors achieve diversification themselves Purchase shares in two separate companies Costly to run larger firms Difficult to reallocate resources effectively Agency costs as profitable divisions subsidise unprofitable divisions
37
Difficulties of merger
Integration Failure Different cultures, working styles, management Creates toxic environment Difficulty to rationalise duplicate departments E.g, difficult to choose between two r&d departments Differences in training, HR processes, production & accounting
38
Treasury Bills
Pure discount bonds with maturities of upto 26 weeks Risk free and liquid Cash immediately available
39
Treasury Notes
semi-annual coupon bonds with maturities between 2-10 Years Low risk as government issued
40
Treasury Bonds
Semi-annual coupon bonds with maturities longer than 10 years
41
TIPS
Bonds with coupon payments that adjust with inflation Final payment protected against deflation since value of final payment is maximum between FV and inflation adjusted FV
42
Why does the yield of a bond that trades at a discount exceed a bond's coupon rate?
Discount implies that bond is trading at less than par on FV When bond matures receive full FV back When priced at discount, return to the holder will be fixed known coupons + difference between FV and below par price paid for bond.
43
Cannibalisation
Decrease in sales of current project because of launching of new project
44
Sunk Cost
Money that will be paid regardless of decision whether or not to proceed a project
45
Opportunity cost
Value of unused space that will be used as new capital budgeting project
46
What is price to earnings ratio?
Widely used financial indicator Investors think a firm has good growth potential Current price reflects investor belief about a firm's future earnings Ratio of current market price and EPS of a stock Major price corrections if future earnings prove to be short of their forecast If a PE ratio is based on most recently reported earnings, a low PE suggests that market price is low Infers market has doubts about future earnings growth
47
What options does a firm have to spend its free cash flows?
Retain them and use for investment opportunities Hold them in cash reserves in anticipation of future financing requirements Pay then to equity holders via dividend or share repurchase
48
3 mechanisms to repurchase shares
Open market repurchase - repurchase shares in open market and common in US Tender off - repurchase a fixed number of shares, for a fixed price Targeted Repurchase - not open to all shareholders, only specific shareholders can tender shares
49
Which policy, either dividend or share repurchase makes investors better off?
Share repurchase - investor will have cash from repurchase Dividend - Investor receives cash dividend which offsets any reduction in value of shares
50
What two primary mechanisms can ownership and control of a public corporation change?
Corporation can acquire target firm Target firm can merge with another firm
51
Why do mergers cluster in time, causing merger waves?
Occur during periods of economic expansion Consumer confidence is high and bullish markets drive up price Mergers looking for investment opportunities to create shareholder value Investors more willing to invest in M&A
52
Reasons for horizontal merger and why is creates value for shareholders?
Combine two firms in same industry Greater potential synergies to eliminate redundant functions Increases price power with both vendors and customers
53
Concerns with post merger integration structure with intellectual capital compared to buying physical capital
If you are buying lots of intangible assets such as human capita, you have to be concerned about how you create incentives for target’s employees to stay on Retention bonuses common for employees Difficult to be successful with hostile acquisition when retention of target employees is critical Keeping uncertainty low and moving quickly during integration is important
54
Why shouldn’t managers acquire firms in different industries to diversity a company?
Investors can diversify themselves by purchasing shares in different companies Not efficient for managers diversity the company rather than leaving it to investors to manage their portfolios
55
Difficulties with a typical merger
Integration of product lines Processes Training R&D Merging two corporate cultures

Econ304 - Business Finance (5 decks)

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