Module 5

Question 1

represents the funds used to finance a firm’s assets and operations

Answer 1

Capital

Question 2

minimum (hurdle rate) of return which a frim must earn on its investments to provide a return to the providers of the funds based on the risk of the assets

how the market views the risk of the firms assets and they are used

if investors are compensated for their financing the frim must earn a return higher than the cost of financing

a % return

Answer 2

Cost of Capital

Question 3

how the market views the RISK of the firms assets and how they are used

Answer 3

Cost of Capital

Question 4

the required return on the overall firm

also the rate appropriate for cash flows that are similar in risk to those of the overall frim

Answer 4

Weighted Average Cost of Capital (WACC)

Question 5

rate that must be earned on an investment project if the project is to increase the value of the common shareholders investment

also be referred to as the firms opportunity cost of capital

if financed with equity capital the cost of ___________ is equal to the required return on common stock

if a frim were to earn its __________ we would expect the price of its common stock to remain unchanged

Answer 5

Cost of Capital

Question 6

the return that is required by investors and is based on the risk of the firm’s cash flows

Answer 6

Cost of Equity

Question 7

quantitative method used for predicting the price of a company’s stock based on the theory that its present-day price is worth the sum of all of its future dividend payments when discounted back to their present value. It attempts to calculate the fair value of a stock irrespective of the prevailing market conditions and takes into consideration the dividend payout factors and the market expected returns.

Answer 7

DDM Dividend Discount Model

Question 8

3 valuation metrics for paying dividends

Answer 8

average sales growth for the past 5 years exceeds 10%
debt to equity ratio must not exceed one
profit margin must exceed 20%

Question 9

True/False

The SML model is the same as the CAPM

Answer 9

True

Question 10

Drawbacks

Only works if the firm pays dividends
If dividend growth is not consistent it may not be applicable
estimated cost of equity is very sensitive to the firm’s estimated growth rate
risk is not specifically considered

Answer 10

DDM Model Drawbacks

Question 11

refers to the equity return based on market risk

Answer 11

Re (SML equation)

Question 12

cost of debt, or the required return on a company’s debt

Answer 12

Rd

Question 13

Corporations receive a ______ _______ on the interest paid on debt, this reduces their after tax cost of debt

Answer 13

Tax Break

Question 14

what is received by the investor if all promised coupon payments are made, the bond is held to maturity and the par value is returned at maturity

Answer 14

Yield to Maturity

Question 15

True/ False

There is no tax break for the frim on their preferred stock

Answer 15

True

Question 16

minimum return a company need to earn to satisfy all its investors, including stockholders, bondholders, and preferred stockholders.
ALSO
The rate of return a firm earns on its existing assets to maintain the current value of its stock

Answer 16

WACC

Question 17

individuals and institutional investors can purchase securities. the securities are initially sold by the managing investment bank firm. The issuing frim never actually meets the ultimate purchaser of securities.

Answer 17

Public Offering

Question 18

securities are offered and sold to a limited number of investors

Answer 18

private placement

Question 19

a company’s first equity issue made available to the public

Answer 19

IPO

Question 20

a new equity issue of securities by a company that has previously issued securities to the public; sale of additional shares by a company whose shares are already publicly traded.

Answer 20

Seasoned equity offering

Question 21

market in which new issues of securities are sold to initial buyers. The only time the issuing firm ever gets any money for the securities

“The Frim is Selling” is this type of market transaction

Answer 21

Primary Market (initial issue)

Question 22

market in which previously issued securities are traded. The issuing corporation does not get any money for stocks traded on this market

investor A sells to investor B the FIRM DOESNT GET ANY MONEY

Answer 22

Secondary Market

Question 23

a group of investment bankers or underwriters that market securities and share the risk associated with selling the issue; compensation comes from the spread

Price stabilization is an important component of the job for IPO offerings

Answer 23

Underwriting Syndicates

Question 24

the difference between the underwriters buying price and the offering price; its the underwriters main source of compensation

Answer 24

Spread

Question 25

means assuming the risk. money for securities is paid to the issuing frim before the securities are sold; there is a risk to investment banking

Answer 25

Underwriting

Question 26

Once the securities are purchased from the issuing frim the are ____________ investors

Answer 26

distributed

Question 27

issuing frim selects an investment banker to underwrite the issue. The frim and the investment banker negotiate the terms of the offer often done under frim commitment where the underwriter buy the negotiated amounts of shares. The frim is paid for the full amount of the negotiated number of shares

Answer 27

Negotiated purchase "frim commitment"

Question 28

several investment bankers bid for the right to underwrite the firms issue. The frim selects the investment banker offering the highest price

Answer 28

Competitive Bid

Question 29

Issue is not underwritten, no money is paid, no risk for the investment bank Investment bank attempts to sell the issue for a commission on each share actually sold. The investment bank only pay's for what is actually sold.

Answer 29

Best Efforts

Question 30

Investment banker helps market the new issue to a select group of investors, targets are current stockholders, employees, and/or customers

Answer 30

Privileged Subscription, or Rights Offering

Question 31

prevents insiders from selling their shares for some period after the IPO (180 days). Can cause the stock price to drop right before the 180 day expiration Agreement specifies how long insiders must wait after an IPO before they can sell some or all of their stock (180 is common but it can be shorter/longer)

Answer 31

Lockup agreements

Question 32

a period of time around the IPO when company employees and the underwriters must limit communications with the public to "ordinary announcements and other purely factual matters" done to prevent too much publicity and speculation in the hope of increasing demand for the stock

Answer 32

Quite Period

Question 33

refers to raising money directly from prominent investors such as life insurance companies and pension funds. Can be done with or without investment bankers

Answer 33

Private Debt Placement

Question 34

Advantages of private debt placement

Answer 34

Faster to raise money reduces flotation cost financial flexibility NEGATIVES High interest cost restrictive covenants possible future SEC registration

Question 35

the listing of an initial public offering (IPO) below its market value, stock is considered to be ________ , demand will drive the price towards its intrinsic value

Answer 35

underpriced

Question 36

For an IPO, this is the price at which a company or more commonly the underwriter sells its shares to its initial investors for

Answer 36

IPO

Question 37

the price at which those begin to trade in the open market on that first day of trading

Answer 37

Opening price

Question 38

the price at the end of the 1st day of trading

Answer 38

closing price

Question 39

True/False A reduction in the market rate of return would reduce market risk premium, reducing the cost of capital

Answer 39

True

Question 40

TRUE The cost of equity is NOT affected by the tax rate. Dividends are NOT deductible

Answer 40

True