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Corporate Finance > Test 2 > Flashcards

Test 2 Flashcards

1
Q

FV equation

A

FV = PV * (1+r)^t

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2
Q

Basic PV equation

A

PV = FV / (1+r)^t

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3
Q

Annuity Formula Assumptions:

A

First cash flow comes in 1 period
Periodic cash flow must be constant
There must be a fixed endpoint for cash flows

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4
Q

The value of financial securities is equal to what?

A

PV of expected future cash flows

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5
Q

YTM definition

A

The market interest rate that sets the PV of bond cash flows equal to its price

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6
Q

In what way are yields and bond prices related?

A

Inversely

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7
Q

Cost of Capital Definition

A

The expected rate of return that investors will collectively require based on firm risk

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8
Q

What must Cost of Capital equal?

A

Opportunity Cost of Capital

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9
Q

What does WACC determine?

A

The Cost of Capital

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10
Q

CAPM definition

A

The equation that shows the relationship between systematic risk and the expected return for an asset

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11
Q

Risk Premium equation

A

ER-rf

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12
Q

Market Risk Premium equation

A

rm-rf

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13
Q

CAPM Assumptions:

A

Investors can buy and sell at the competitive market price and can borrow and lend at the risk free rate
Investors hold only efficient portfolios
Investors have collectively have the same expectations of the market

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14
Q

Operating Leverage definition

A

The sensitivity of profits to the fixed costs of production

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15
Q

Financial Leverage definition

A

The proportion of a firm that is financed with debt

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16
Q

Cost of Debt (rd) equation

A

YTM * (1-tax)

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17
Q

To find the Cost of Equity for a private firm (READ)

A
  1. Find a similar firm
  2. Get the equity beta and remove leverage to get the asset beta
  3. average multiple comparable firms asset betas
  4. Relever the asset beta based on the private companies debt to equity ratio
  5. Apply the CAPM
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18
Q

What does the appropriate discount rate depend on?

A

It depends on the risk of the project (NOT the risk of the firm)

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19
Q

PV of the Interest Tax Shield Equation:

A

Tax * Debt

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20
Q

Debt Overhang definition

A

Too much debt can lead to firms bypassing positive NPV investments

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21
Q

Agency Costs definition

A

Costs that arise when different firm stakeholders have different objectives

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22
Q

Asset Substitution definition

A

When a firm faces financial distress shareholders can gain at the expense of debtholders by taking a risky negative NPV project

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23
Q

Debt Overhang definition

A

During financial distress, when equityholders dont invest in positive NPV projects because the value of taking the project will go more towards debtholders

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24
Q

Cashing Out definition

A

During financial distress, shareholders may sell assets below market value and use the funds to pay themselves a cash dividend

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25
Q

What type of contract helps mitigate agency costs?

A

Covenants

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26
Q

Who bears most agency costs?

A

Shareholders

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27
Q

Managerial Entrenchment definition

A

When managers make decisions that benefit themselves at the investors expense

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28
Q

Concentration of Ownership definition

A

Leverage allows original shareholders to preserve their equity stake, making them more likely to work towards maximizing firm value

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29
Q

Free Cash Flow Hypothesis definition

A

Leverage increases frim value because it commits the firm to making future interest payments, reducing excess cash flows and spending by managers

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30
Q

What are the three types of terminal values?

A

Scuttle - Abandon the asset
Liquidate - Sell the asset and reclaim NWC
Sell as a Going Concern

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31
Q

NPV definition

A

The value added to the firm from accepting the project

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32
Q

IRR definition

A

The measure of annualized percentage return on the project

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33
Q

Payback definition

A

How long it takes to recover your investment

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34
Q

What does IRR ignore

A

Scale

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35
Q

When is payback best used?

A

For smaller decisions

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36
Q

What are the three cash flows to include in Capital Budgeting?

A

When money changes hands
Opportunity Costs
Side effects to other projects

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37
Q

What is the best way to work with Opportunity Costs?

A

Evaluate each choice separately and then pick the one with the biggest NPV

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38
Q

What two important things do we not include as cash flows?

A

Interest and Dividend Payments

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39
Q

What is Equivalent Annual Annuity also called?

A

Equivalent Annual Cost

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40
Q

EAC definition

A

It takes the NPV for the project and calculates what annuity cash flow over the projects life is the same as the NPV

41
Q

What is the WACC for Project Valuation with Leverage equation?

A

VL0 = FCF1/1+rwacc + FCF2/(1+rwacc)^2…

42
Q

Debt Capacity definition

A

The amount of debt required to maintain a firms target debt to value ration

43
Q

Debt Capacity (Dt) equation

A

D * VLt

44
Q

Efficient Markets Hypothesis

A

Security prices reflect all available and relevant information

45
Q

3 Forms of Efficiency

A

Weak Form
Semi Strong Form
Strong Form

46
Q

Weak Form Efficiency

A

Prices reflect all historical trade data

47
Q

Semi Strong Form Efficiency

A

Prices reflect all publicly available information

48
Q

Strong Form Efficiency

A

Prices reflect all relevant information, public and private

49
Q

Event Studies

A

Studies that examine prices and returns around the arrival of new information

50
Q

What form of efficiency is the market usually?

A

Semi Strong Form

51
Q

Do active managed funds over or under perform on average?

A

Underperform

52
Q

4 Characteristics of Venture Capital Funds (read)

A

The Investment is made in illiquid securities
The Investment is in equity and the stake cannot be sold for a certain period
The investment is made for 2 to 5 years with the expectation of growth by the sale/exit
The project is very risky

53
Q

4 Stages of Venture Capital

A

Stage 0 - Establish the Fund
Stage 1 - Deal Flow
Stage 2 - Value Creation
Stage 3 - Harvesting and Distribution

54
Q

Private Equity Firm

A

They make public companies go private through LBO’s (Leveraged Buy Outs)

55
Q

IPO definition

A

The Initial Public Offering of stock

56
Q

Underwriters definition

A

The lead investment bankers who help with an IPO

57
Q

2 Types of IPO offerings

A

Firm Commitment
Best Effort

58
Q

Firm Commitment IPO Offering

A

The traditional underwriting where the underwriter is responsible for any unsold shares

59
Q

Best Efforts IPO Offering

A

The underwriter does not guarantee that stock will be sold but tries to sell it for the best possible price

60
Q

How long does the IPO process take?

A

About 8-12 weeks

61
Q

Once approved by the SEC, what does the Registration Statement become?

A

The Preliminary Prospectus that is given to potential investors

62
Q

What are Investment Bankers paid from an IPO?

A

The Gross Spread (typically 7%)

63
Q

Gross Spread

A

The difference between price chares that are bought from the firm and sold to investors

64
Q

How are IPOs typically priced?

A

Underpriced

65
Q

Seasoned Equity Offering

A

Has the same mechanics as an IPO but establishing an offer price is easier

66
Q

Special Purpose Acquisition Company (SPAC)

A

A public shell company that is created to find a target private firm and take it public by merging it with the SPAC

67
Q

Bond Indenture

A

The legal contract between the bond issuer and the trust company representing the bondholders that is included in the prospectus

68
Q

Bearer Bond

A

To receive the coupon payment you had to clip the coupon off the bond certificate and give it to the paying agent

69
Q

Registered Bond

A

Coupon payments are only made to the people on the bond holder lists

70
Q

Subordinated Issue

A

Debt that has a lower priority claim to the firms assets

71
Q

Types of Private Debt

A

Term Loan
Syndicated Bank Loan
Revolving Line of Credit
Private Placement

72
Q

Term Loan

A

Bank loan that lasts for a specific term

73
Q

Syndicated Bank Loan

A

Loan that is funded by a group of banks

74
Q

Revolving Line of Credit

A

A credit commitment for a specific time period that a company can use as needed

75
Q

Private Placement

A

A bond issue sold to a small group of investors

76
Q

Where is Call Price usually set compared to a bonds face value

A

At or above it

77
Q

What is a Callable Bond price capped at?

A

The Call Price

78
Q

Conversion Price Equation

A

Face value of Convertible Bond / number of shares received if converted

79
Q

Warrant definition

A

Call option written by the company on a new stock

80
Q

Sovereign Debt

A

Debt issued by a national government

81
Q

Collateralized Debt Obligation

A

The resecuritization of other asset backed securities

82
Q

Cash Cycle

A

The length of time between when a firm pays to purchase inventory and receives cash from selling a product

83
Q

Operating Cycle

A

The length of time between when firm gets inventory and receives cash from selling a product

84
Q

Which is shorter, the cash cycle or operating cycle?

A

the Cash Cycle

85
Q

Permanent Working Capital

A

The amount that a firm must keep invested to support operations

86
Q

Temporary Working Capital

A

The difference between actual working capital and permanent working capital

87
Q

Special Dividend

A

A one time dividend that is usually much larger than a regular dividend

88
Q

Stock Dividend

A

A dividend in shares of stock rather than in cash

89
Q

Return of Capital Dividend

A

Paying dividends from other sources than current earnings (Ex: from the sale of assets)

90
Q

Liquidating Dividend

A

The return of capital to shareholders from the termination of a business operation

91
Q

4 Dividend Timing Dates

A

Declaration Date
Ex-Dividend Date
Record Date
Payable Date

92
Q

Declaration Date

A

The date that the board of directors authorizes the payment of a dividend

93
Q

Ex-Dividend Date

A

2 days prior to the dividend record date where eligibility for the dividend is locked in

94
Q

4 methods of share repurchasing

A

Open Market
Tender Offer
Dutch Action
Targeted

95
Q

Open Market Repurchase

A

A normal repurchase

96
Q

Tender Offer Repurchase

A

A public announcement of repurchase at a premium. If shareholders dont tender enough shares the buyback can be canceled

97
Q

Dutch Action Repurchase

A

The firm lists different prices it is prepared to buy shares at and the shareholders say how many shares they will sell at each price

98
Q

Target Repurchase

A

The firm purchases shares from a specific shareholder

99
Q

In a perfect capital market, does an open market repurchase have an effect on stock price?

A

No, so investors are indifferent to getting a dividend or share repurchase

Corporate Finance (3 decks)

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