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FM general Flashcards

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1
Q

Hard capital rationing

A

External capital markets limit the supply of funds

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2
Q

Soft capital rationing

A

Firm imposes it’s own internal constraints on the amount of funds to be raised and investment in projects. Budgetary constraints. Can also arise where it is impractical for the firm to go to markets and raise a small amount of finance

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3
Q

Arbitrage Pricing Theory

A

Similar to CAPM. It adds a premium to the risk free rate but rather than just a single premium… the model divides the premium down into lots of bits.
Different authors have suggested different things such as inflation, level of industrial output, interest rates, size of the company .

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4
Q

Capital Asset Pricing Model (CAPM)

A

Way of estimating the rate of return that a fully diversified equity shareholder would require from a particular investment.

Rj = Rf + beta (rm-rf)

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5
Q

Problems with CAPM

A 
RM = usually done with historic rate rather than future returns
Rf = gilts are not risk free
Beta = calculated using stat analysis of the difference between market return and the return of a particular share or industry. - way too simplistic.
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6
Q

Dividend policy - traditional

A

A consistent dividend stream was important

It was believed that it was better to have the certainty of a known dividend now than the uncertainty of having to wait.

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7
Q

Dividend policy - Modigliani and Miller

A

pattern of dividends does not affect shareholder wealth
As long as directors focus on investing into positive NPV projects, an increased dividend in the future will compensate for the cut today

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8
Q

M&M - DIY dividends

A

If money is needed today then shareholders can “manufacture dividends” by selling shares

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9
Q

Dividend Signalling

A

M&M assumed investors had perfect information about the company. In practice, although this is true for small owner managed businesses, with listed companies, a reduction in dividend can convey “bad news” to shareholders,

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10
Q

Clientele effect

A

M&M assumed investors were indifferent between dividends and capital growth. & if an investor required cash then he could manufacture dividends by selling shares. (investors have a preferred habitat).

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11
Q

Pecking Order Theory

A

A firm would generally choose in the following order if possible

(1) Retained profit - immediate no issue costs
(2) rights issue - some issue costs but no control or value given away
(3) as a last resort a new issue - expensive and difficult to price

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12
Q

Interest Cover equation

A

operating profit / interest

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13
Q

Financing Questions (FAT PRICE)

A 
Financial risk
Analysis and discussion
Theory
Practical gearing
Ratios - Interest cover & hearing
Industry Averages
Conclusion
Easy marks - financing checklist
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14
Q

No tax theory of Modigliani and miller 1958

A

Based on the premise of a perfect capital market

  • no transaction costs
  • no individual dominates the market
  • full information efficiency
  • all investors are rational and risk averse
  • no taxes
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15
Q

With tax theory of Modigliani and miller

A

1963 m&m modified their model to reflect corporate tax system
Debt interest is tax deductible so kd is lower
Increase in ke does not offset the benefit of cheaper debt finance

WACC falls as gearing increases.

Summary
Gearing up reduced the WACC
Optimal capital structure is 99% gearing

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16
Q

Problems with high levels of gearing

A

Increased bankruptcy
Tax exhaustion - company profits are not high enough to cover the interest costs
Agency costs _ directors more risk averse

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17
Q

Asset beta

A

Beta measuring systematic business risk only

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18
Q

Equity beta

A

A beta reflecting systematic business risk and the firms level of gearing

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19
Q

Scrip dividend

A

Where a company allows shareholdersthe choice of taking dividends in the form of new shares rather than cash

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20
Q

Advantage of scrip dividend

A 
Shareholders = painlessly increase their shareholding in the company without paying shareholder commission or stamp duty on a share purchase
Company = does not have to find cash to pay dividend and can save tax
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21
Q

Advantages of growth by acquisition

A

Synergy
Risk reduction
Reduced competition
Vertical protection

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22
Q

Disadvantages of growth by acquisition

A

Synergy is not automatic
Restructuring costs following the acquisition may be significant
May end up paying more in terms of both price and fees than it gains in synergic benefits

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23
Q

Dividend yield

A 
Yield = dividend / price
Price = dividend / yield
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24
Q

Dividend valuation model

A

Value is simply the present value of the future expected dividend payments discounted at Ke

Dividends are expected to grow by a constant rate in perpetuity then:

PV = d1 x 1/ke - g

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25
Problems with dividend based valuation
Estimating future dividends Finding similar listed companies If ke is estimated by CAPM or by looking at other quoted companies then a private co valuation will need to be reflected downwards to reflect lack of marketability (-25%)
26
PE multiple valuation
Equity value = earnings x PE ratio Earnings are PAT and preference dividends
27
EBITDA multiple
Enterprise value = EBITDA x EBITDA multiple
28
Enterprise value
Market value of equity + preference shares + minority interest + debt - cash and cash equivalents
29
Cash flow based approach
PV cash flows to infinity discounted at WACC x | Less MV of debt (x)
30
Spin off
Shares in subsidiary company are given to the shareholders of the parent in proportion to their shareholdings
31
crowdfunding
allows a company to access finance from a large number of investors using a specific platform.
32
crowdfunding - advantages
useful for start-up companies with no trading history provides a business awareness to attract customers can be a quick process
33
crowdfunding - disadvantages
fee payable to the CF website legal / advisory costs admin cost of dealing with investor requests for more info
34
Peer-to-peer lending
connects established businesses looking to borrow with investors who want to lend, usually via an online platform
35
p2p - advantages
- usually lower interest rates - quicker to arrange - more accessible esp for those with low credit ratings
36
p2p - disadvantages
- require a high track record and credit checks will be performed - can require an arrangement fee
37
Predictive analytics
use historical and current data to create predictions about the future. e.g. linear regression models, decision trees, simulations.
38
Linear Regression Models
statistical tool used to identify the relationship between two variables ADV: simple to use, easily explained and can be used to predict the impact from changes in estimates DISADV: less meaningful if data is inaccurate, not always be a linear relationship, or spurious
39
Decision trees
used to identify the impact of different decisions on the outcome of an investment ADV: simple, logical, used to consider multiple decisions DISADV: many decisions can be difficult to interpret
40
simulation
looks at the impact of many variables changing at the same time adv: provides more info about possible outcomes and sensitivities, & used for problems that cannot be solved analytically disadv: does not identify a correct decision, time-consuming and complex, expensive & requires assumptions to be made
41
Prescriptive analytics
combining predictive with AI and algorithms, prescriptive can be used to calculate the optimum outcome from a variety of business decisions ADV: multiple decisions and variables to identify the optimum investment DISADV: complex and requires specialist data science skills depends on reliability of data
42
Strong form efficiency
share price at all times incorporates all information that exists about the company. SP moves instantly, insider trading is not possible
43
Semi Strong form efficiency
incorporates all information that has been made public about a company. Insider trading is possible if moved before public
44
Weak form efficiency
when a new event happens, the share price does not react instantly. It takes time for the new information to be reflected in the price.
45
PE Valuation
PAT - preference dividend = x EPS = x / ordinary shares = y y x PE ratio = x less non marketability (25%) Valuation x
46
problems with PE valuation
profits may be erratic and so valuation will be unreliable accounting policies may be used to manipulate earnings figures finding appropriate listed companies is the non-marketability reasonable?
47
rights issue
Issue costs underwriting costs if company decides to protect its position control - no dilution of control for those who take up their rights need to discount offer price so that issue is fully subscribed leaves credit lines open to finance further expansion
48
floating rate loan
avoiding being tied into higher fixed rates is market interest rates fall risk of interest rates rising - cash budgeting problems issue costs less than rights issue early repayment - possibility
49
Shareholder Value Analysis SVA
Concentrates on a company's ability to generate value and thereby increase shareholder wealth.
50
SVA - 7 drivers
1. life of projected cash flows 2. sales growth rate 3. operating profit margin 4. corporate tax rate 5. investment in non current assets 6. investment in working capital 7. cost of capital
51
Valuation of tech companies
Asset method - difficult to apply because the value of tangible assets may not be high Earnings method - low earnings in the early years Dividend method - no dividend will be paid likely Market multiples - possible to use ratios based on similar companies Discounted cash flow - most likely valid approach. Different scenarios and cash flows could be modelled based on companies with similar business model
52
Single cash flow
cash flow x 1 / (1+r)^n
53
Perpetuity cash flow
A constant annual cash flow occurring forever PV = annual CF x PF With growth: (PF * g / (r - g) ) * 1/1+r^n
54
Annuity Cash flow
A constant annual cash flow occurring for a SET number of years (formula given)
55
SVA adv
values the free cash flows of the company and is not distorted by accounting policies which can affect other methods.
56
SVA disadv
dominated by the terminal value. | heavily dependent upon the inputs to the model such as estimating cash flows and growth.
57
Paying for ordinary shares - cash | ADVANTAGES
- buyer gets full control & entitlement to profits | - seller receives a certain unconditional amount
58
Paying for ordinary shares - cash | DISADVANTAGES
- find cash somewhere - capital gains tax liabilities arise immediately - sellers expertise may be lost as no motivation for them to stay
59
share for share exchange - ADVANTAGES
- no need to fund a cash payment - seller is motivated to stay for work - CGT deferred
60
share for share exchange - DISADVANTAGES
- control is diluted | - future profits shared with seller
61
Loan stock in exchange for shares - advantages
- advantages of cash payment with no need to find immediate finance
62
Loan stock in exchange for shares - disadvantages
buyer will have to pay interest on the debt until it is redeemed
63
Traditional View of gearing
low levels - equity holders see risk being relatively unchanged. - cheaper debt is incorporated - WACC falls high levels - equity holders see increased volatility of returns as debt interest is paid first - increased equity risk increases ke and WACC starts to rise very high levels - bankruptcy risk - kd + ke rise, WACC rises further
64
Unpublished information
remain confidential not be disclosed not to be used for a personal advantage
65
Market Capitalisation < Net Assets
- worth more if liquidated - assumes that the NBV matches the MV. - Market may see no future in the company and already valuing it on break up basis. - dividend low payout (10%) - no plans to re-invest gives a high cash balance - all equity funded, market may think is inadvisable and does not allow brennan to exploit the advantage of debt being cheaper than equity due to tax shield
66
Forward
binding agreement to buy or sell something in the future at a price agreed today
67
Future
forward contract that has been standardised (in terms of delivery date and quantity)
68
What effects the time value of an option?
1. time period to expiry of the option 2. volatility of the underlying security price 3. general level of interest rates
69
Risks to trading abroad
``` Currency risk Government Stability Political and business ethics Economic Stability Import Restrictions Remittance Restrictions Special taxes, regulations for foreign companies Trading risks - physical risk, credit risk, liquidity risk ```
70
Time Value
intrinsic value - option premium
71
Intrinsic Value
Options that are in the money will have this.
72
What effects the intrinsic value?
1. Exercise price | 2. Share price
73
PE valuation
MV of ordinary share / EPS
74
Interest rate parity theory
difference between the spot rate and the future exchange rates is equal to the differential between interest rates available in the two currencies. FR = spot rate x (1+foreign currency IR / 1 + UK interest rate)
75
Offer for sale
Shares would be sold to an issuing house, which then offers shares for sale to public
76
Offer for subscription / Direct offer
shares would be directly offered to the public - not an issuing house
77
Underwriting
For a fixed fee, a financing institution agree to purchase any shares not sold by the company.
78
ICO
Raises finance from investors - investor receives a token, - share or entitlement for product or service - payment is made in cryptocurrency.
79
Confidentiality
- different partners and teams - necessary action to prevent leakage of any information - regularly review the situation
80
Convertible debentures
can be converted into ordinary shares adv: - obtaining lower rate of interest - encouraging possible investors with prospect of future share in profits - element of short-term gearing - avoiding the problem of redemption if th e conversion rights are taken up - being able to issue equity cheaply disadv: - dilution of control if conversion rights are taken - uncertainty as to whether they will be taken up
81
Economic risk
Longer term exchange rate movements might reduce the international competitiveness

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