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Flashcards in Term 2 Deck (77):
1

What does an efficent market do?

Provide correct signals to financial managers
Encourage the purchase of shares
Ensure efficient allocation of resources

2

What are the three forms of EMH?

Weak - Reflect Past info
Semi-Strong - Reflect Past and publicly available
Strong - Reflect Past, Public and Private

3

What are the implications of EMH?

As information is freely and immediately available
Prices will adjust instantly
No opportunity for excess returns
Firms cannot fool investors,
Will always receive a fair price for their shares

4

What is implied if analysts are making money?

If technical analysts make money - weak inefficient
If Fundamental analysts make money - semi-strong inefficient
If insider traders make money - strong inefficent

5

What are the implications of EMH for financial decision making?

Use passive investment strategy
Do not consider timing for equity release

6

What are some calendar anomalies?

Calendar Effects

7

What are the two theories on capital structure?

Traditional: There is an optimal structure

Modigliani and Miller (MM) capital structure is irrelevant

8

How do you calculate the value of a firm?

V=E+D
Value
Value of Equity
Value of Debt

Sum Earnings/(1+K)^t

9

How do you calculate Weighted Average Cost of Capital

k=Ke(E/V)+kd(D/V)

10

What is the traditional view with no taxation

Firms can substitute to from equity to debt, increasing risk but lowering average cost of capital

11

What is the MM view with no taxation?

Argues the traditional view will fail, as substitution will cause the ROR on equity to rise

12

What are the assumptions of MM?

Market value is independent of capital structure

The expected ROR on stock increases in proportion to the debt equity ratio

13

What is the cost of debt capital if taxes are included?

Kd(1-Tc)

14

What is a tax shield?

TcD
The saving the firm makes by paying tax deductible interest

15

What level of earnings will shareholders receive in a taxed firm?

(EBIT-KdD)(1-Tc)

16

What is the value of levered firm?

Vl=Vu+Dtc
Levered
Unlevered
Tax times debt

17

How can the value of a levered firm be expressed interms of personal tax?

Vl=Vu+(1-(1-Tc)*(1-Ts)/(1-Tb))*B

Ts is tax on equity income
TB is tax on bond income

18

Discuss bankruptcy and its costs

A high debt-equity ratio increases the risk of bankruptcy

Direct Costs - Cash outflows

Indirect- Arise before firm fails, consumers stopping buying

19

What are the implications of the trade off theory?

Firms with:
volatile cash flows
Intangible assets
Long life products

Will have less debt

20

What are the limitations of trade off theory?

It rules out conservative debt ratios for taxed firms - Opposite empirically

Positive association with profitability and debt

21

Discuss asymmetric information and signalling?

Managers can use a rise in debt ratios to signal all is well

22

What is the simple view of a firm?

Assets:
Existing Investments generating cash flows
Future Investments

Liabilities:
Debt
Equity

23

Discuss the par value of debt?

Par value is issue value
If IR fall, market value > par value

24

What is the value of a firm?

Where assets = liabilities

25

What are the three approaches of company valuation?

Accounting Information:
Stock Market Values
Discounted Cash Flows

26

Discuss accounting information

Financial, P/E and P/B Ratios
This is called relative valuation

27

What are the advantages and disadvantages of accounting information

Information is easily available and adjustable

Fundamentally backwards looking
Can be manipulated

28

Discuss Stock market values

Market Cap:
Price*Number of shares
Requires EMH assumption

29

What are the advantages and disadvantages of Stock Market Valuation

Data is easy to obtain
Allows relative comparisons

Are markets efficient
Quality of information

30

Discuss discounted cash flows

Most Popular Method
Requires a lot of assumptions and information

31

How do you perform a discounted cash flow valuation?

Sum(D/1+ket)

32

What are the two components of systematic risk of equity?

No debt:
Business of operating risk
Re=RF+BRP

Debt:
Financial Risk
Re=RF+BRP+FRP

33

How do you estimate the cost of equity for WACC?

Ke=Rf+B(ERm-Rf)

34

What are the problems with estimating the cost of equity?

Different corporations have different levels of systematic risk
Effected by time horizon
Can be problematic if many tranches of debt

35

What is Gordons Dividend Model?

V=FCF/WACC-g

Free cash flow
G is growth of FCF

36

How do you exectue the dividend cash flow valuation?

Forecast FCF

Determine the WACC

Estimate Continuing Value

Assess the Value of Equity

Test the Results

37

How do you calculate FCF?

FCF=EBIT(1-Tc)+Deprecation - Net Investment - Increases in working capital

Net Investment = Capital Expenditures - Depreciation

38

How do you calculate the WACC with tax?

k=Ke(E/V)+kd(D/V)(1-Tc)

39

How do you calculate the systematic risk of assets?

BA=(D/D+E)BD+(E/D+E)BE

Systematic risk of assets, BA
Systematic risk of equity, BE
Systematic risk of debt, BD

40

What factors effect valuation?

Acquisitions
Management buy outs
New Issues
Liquidations

41

What is the key issue of Dividend Policy?

Pay out and the frequency
Cash or Share Repurcahase
Regular or Sepcial
Needs of Investor

42

Types of Dividends

Special Dividends - One off
Stock Dividend - More Shares
BuyBacks

43

What are the two theories on dividiends?

Traditional - More Dividends = Higher Value
MM - Dividend policy irrelevant

44

What occurs to the dividend policy if the market has imperfections?

Policy becomes relevant to value

45

What happens if taxation is present?

If personal taxes are incldued, firms should retain all income as CG it taxed at a lower value

Firm value falls if dividends paid

46

What are the advantages of share repurchase?

Provides investers with more choice

Flexibility to firm

Dividend Tax avoidance

Increase control

47

Why do firms pay dividends?

Despite all disadvantages:

Clientelle effect
Signalling
Agency Problem

48

Define Clientelle Effect?

Firms choose dividend polict based on tax rates of investors

49

How can investors be divided under the clientelle model?

High Tax - Prefer no dividends

Low Tax:
Individual - Low Dividends for Income
Institutional - Prefer Dividends for income
Corporations - High Dividends

50

What is the issue of the clientelle effect?

There are enough high paying dividend firms to satisfy investors, thus no boost to be gained

51

What is signalling?

Dividend reflect managers beliefs
Can be reversed, high dividends = Lack of opportunities

Also dividend smoothing

52

Discuss agency costs?

Dividends can prevent managers from using excess cash inefficently

53

What is some empricial evidence on dividends?

Dividends are being replaced by BuyBacks
Dividend Smoothing Exists
High Tax Brackets = More Dividends

54

Define Merger

A transaction where two firms agree to integrate options

55

Define Acquisition

A stratergy where one firm buys 100% of another firm

56

Defien takeover

A acquisition where the target firm did not solicit the bid

57

What are the three types of mergers?

Horizontal
Vertical
Conglomerate

58

Who are the gainers and looses of mergers?

The target firm gains
The acquirer looses out

59

Discuss the acquisition premium

Acquirers pay an average premium of 43% over true value

60

Discuss the Key Steps of a Merger?

Valuation
Public Offer
Hostile V Friendly
Methods of Payment
Tax Issues
Approval

61

Discuss Hostile V Friendly?

If proposed to managers and they agree - Friendly

If Resisted, submit tender offer - Hostile

62

Discuss cash v stock?

Cash is simple
Stock is where firm issues stock to give to shareholders

Exchange ratio is the number of shares recited for each share

63

Discuss Tax issues?

If paid in cash, instant tax liability
If in shares, defered

64

Who must the deal be approved by?

Both sets of managers
UK Regulator

65

What are the reasons for Mergers?

Economies of Scale, Scope and VI
Efficiency Gains
Diversifcation

66

problems with Mergers?

EPS and Tax motives do not work
Multiple different perspectives to be considers

67

To what parties are mergers beneficial?

Not always underperforming companies
Better for society
Acquirer bad
Target Good
Employees Lose
Directors loose
Finanical Institutions win

68

How do you analyse a merger using short term event studies?

Calculate abnormal returns within the time window for each day through:
Ra=R-E(R)
Calculate Statistical Significance

69

Why do the targets earn higher returns?

Acquirers bids to higher price
Loss of Control
Loss of Potential Gains
Competition

70

What is the hubris hypothesis?

The winning firm will over bid,
Market is efficent, but bidders make mistakes

71

What are the Antitakeover Defences?

Poison Pill
White Knight Defence
Shark Repellents
Greenmail
Supermajority Amendments
Golden Parachutes

72

What is a posion pill?

Target shareholders given right to sell at discounted prices

73

What is a white knight defence?

Managment calls upon a friendly investor to intervene

74

What is a shark repellents

Amendments to corporate charter to make it more difficult

75

What is a greenmail

Buying off the shares

76

What is a supermajority amendments

Making it require a large approval to go ahead

77

What are golden parachutes

Illegal large termination bonuses for execuitves