Financial Management

Question 1

Why is firm leverage irrelevant for shareholders?

Answer 1

Same capital invested in levered and unlevered (percentage wise of whole equity) –> same returns

Question 2

What are disadvantages of the Payback Period?

Answer 2

There are several disadvantages: it does not discount CF (does not take into account TVM); does not consider the CF after the payback period; it is an arbitrary decision rule.

Question 3

What are advantages of the Payback Period?

Answer 3

The biggest advantages of the payback period as a decision rule are that it is simple to compute and easy to explain / communicate.

Question 4

How can you call systematic risk as well?

Answer 4

idiosyncratic risk

Question 5

Common Stock

Answer 5

• Dividends are unpredictable
• Voting shares

Question 6

Preferred Stock

Answer 6

• Dividends predetermined
• Mostly no voting power
• Senior to common stock

Question 7

Priority terms

Answer 7

Senior vs Junior

Question 8

Control on company of Debt on Company and example

Answer 8

Covenants
- no extraordinary dividends
- want to limit investment decisions

Question 9

Systematic risk: two factors /Business risk

Answer 9

• cyclicality of revenues
• Operation leverage

Question 10

Idiosyncratic risk

Answer 10

Specific risk

Question 11

Specific risk is also called

Answer 11

Idiosyncratic Risk

Question 12

What kind of repayments have bonds usually?

Answer 12

Bullet Payment

Question 13

What is a syndicated loan?

Answer 13

Loan from multiple debt holders

Question 14

Bonds maturity?

Answer 14

Longer term

Question 15

Notes maturity

Answer 15

Medium term

Question 16

Commercial paper maturity

Answer 16

short term

Question 17

Length of short, medium and long term

Answer 17

• Short-term (<1 year)
  ▪ Medium-term (1-5 years)
  ▪ Long-term (>5 years)

Question 18

Which debt is mostly more expensive?

Answer 18

long term debt

Question 19

Amortizing repayment

Answer 19

Installments throughout time –> Loans

Question 20

Bullet repayment

Answer 20

Principal payment at once at the end (often bonds)

Question 21

Interest rate

Answer 21

• Fixed Vs Floating (changes over time, dependent on market conditions, EURIBOR)
• Derivates are one type of interest rate swaps (from floating to fixed)
• Rating/Spread: Interest rate depends on credit worthiness

Question 22

Credit worthiness/Ratings are dependent on

Answer 22

• Ability to generate cash-flows
• credit worthiness of its assets
• current level of leverage

Question 23

Dual class

Answer 23

Class A vs Class B Shares
- differences in voting power & dividends
- Class A more power but also more expensive
- Advantage: smaller investors are attracted

Question 24

Dual Listing

Answer 24

Public companies might have different entities (legally) but shares are about one company with one profits. Managing and financing is together

Question 25

Shares to employees

Answer 25

- dilution for current shareholders - locking employees

Question 26

Dividend in kind

Answer 26

Instead of giving cash you give asset

Question 27

Companies with intangibles are usually mostly financed with:

Answer 27

Equity

Question 28

Companies with a lot of tangibles/assets that can serve as collateral are mostly mainly financed with:

Answer 28

Debt

Question 29

Financial distress costs: direct costs

Answer 29

- Legal expenses - Court costs - Advisory fees

Question 30

Financial distress costs: Indirect Costs

Answer 30

- result from financial distress - Reputation (spare parts, customer relationship (airlines), Suppliers stop sending raw materials, lose flexibility cause closer observed by creditors) -> less revenue - Fire Sales

Question 31

Financial distress costs: Agency Costs

Answer 31

- Risk Shifting - Debt overhang - Cashing out

Question 32

Risk Shifting

Answer 32

Shareholders may take high risk, negative NPV projects in the hope of realizing the upside potential, leaving bondholders to bear the downside risk (overinvestment)

Question 33

Debt Overhang

Answer 33

Shareholders may be unwilling to finance positive NPV projects when the firm is in financial distress since debt holders have priority over the CFs (underinvestment)

Question 34

Cashing Out

Answer 34

Shareholders may try to get money out of the firm ahead of higher priority claims (e.g. by paying cash dividends)