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FTCP > Term 2 > Flashcards

Term 2 Flashcards

1
Q

What are the decisions of a CFO?

A

Investment - where to invest
Finance - Where to get the money from
Treasury Management - Ensuring cash is available

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2
Q

Discuss Excessive risk?

A

If a firm is close to bankruptcy, the shareholders will take negative NPV projects on the offchance they pay off

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3
Q

Discuss Debt overhang

A

Shareholders will not undertake positive NPV projects as the payoff will go to debt holders

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4
Q

What is the debt overhang cut off

A

NPV/I > Bd/Be * D / E

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5
Q

How can a manager signal with debt?

A

Taking on higher debt signals confidence if his salary is tied to performance

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6
Q

Why cant a manager signal with equity?

A

The issuing of equity implies the firm is overvalued

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7
Q

What is cashing out?

A

If the firm is under financial stres, shareholders will sell assets as else go to debtors

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8
Q

How can you limit cashing out?

A

Higher IR,

Debt covenants

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9
Q

What is the pecking order of capital structure?

A

Retained earnings
Debt
Equity

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10
Q

Give examples of the conflict of interest?

A

Empire building
Insufficent effort
Excessive investments

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11
Q

How might you aline incentives?

A

Give stock or bonuses

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12
Q

What is the disadvantage of stock options?

A

Makes teh manager harder to fire as he has a board say

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13
Q

Discuss a contract is effort is observable?

A

Will only pay for high effort

U(w)-A>=U

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14
Q

Discuss the maximisation problem?

A

Max Ph(Xs-Ws)+(1-Ph)(Xf-Wf)
S.t.
Inecntive Constraint:
PhU(ws)+(1-Ph)u(Wf)-ah>=Plu(ws)+(1-Pl)u(wf)-al

Individual Rationality:
PhU(ws)+(1-Ph)u(Wf)-ah>=U

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15
Q

What is the solution of the maximisation problem?

A

U(ws)=U+ah(1-Pl)-al(1-Ph) / Ph-Pl

U(wf)=U+ alPh-ahPl/ Ph-Pl

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16
Q

Discuss bonuses v share options?

A

Bonuses create a short termsist attitudes

Maximise current profits at the expense of future

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17
Q

What are the disadvantages of share options?

A

Timing: Managers may release bad information before issuing to get a better deal

Backdating: Chaning the option date to maximise returns

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18
Q

What are the MM assumptions?

A 
Perfect Capital MArkets
No Taxes / Transaction costs
Homogenous information
Unlimited borrowing
No Signalling
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19
Q

What is MM1

A

Capital structure does not effect value

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20
Q

What is a firms value?

A

V=E+D = EBIT/Risk

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21
Q

Prove MM1

A

Based on Arbitrage
V1 = D+E
V2 = E

Suppose V2>V1
Investor could short 2 and buy 1
Maths, Creating a profitable opportunity

Suppose V2

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22
Q

Discuss homemade leverage

A

IF IR of personal borrowing and company are same, investors can borrow to adjust holdings

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23
Q

What is the WACC?

A

E/VRe+D/VRd = Ru

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24
Q

How does the D/E ratio effect the firm?

A

The higher the D/E, the higher the KE due to variability

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25
Q

What happends if corporate taxes are introduced?

A

Firms can shield interest payments through tax shield, keeping a higher proportion of cashflows
TcD

26
Q

What is a firms value with corporate taxes, what is its WACC>

A

Vu=Vl+TCd

WACC=E/VBe+D/VBd(1-Tc)

27
Q

What happends if personal taxes are introduced?

A

Due to the double taxing of dividend payments, equity in a levered firm is less useful?

28
Q

What is the value of debts benefits here?

A

T*=1-(1-Tc)(1-Te)/(1-Ti)

29
Q

What are the costs of bankruptcy?

A

Direct

Indirect - Loss of consumers

30
Q

What determins the PV of financial distress?

A

The probability of occurance - Amount of debt, volatility
Magnitude of costs - ease of liquidation
Discount rate

31
Q

Does capital structure matter?

A 
Perfect Markets - No
With corporate Tax - Debt is better
With personal tax - Benefits reduced
With bankruptcy - Equity is better
Agency costs
32
Q

What is the key dividend terminology?

A

Decleration Date - Date board decides
Record Date - Shareholders at this date are eligible
Ex-Dividend Date - After this, no new shareholders
Payable Date - Go figure

33
Q

What are the types of share repurchases?

A

Open Market
Tender Offer - At premium
Dutch Auction - Lowest price that meets desired number
Targeted - Private agreement

34
Q

What is the MM dividend irrelevance model?

A

Vt=NP0=N0(D1+P1/1+R1)
Replace N0 =N1-M1
Redefine P1M1=EBIT1-I1-N0D1

V=V1+EBIT1-I1/1+R

35
Q

What is the dividend puzzle?

A

Why take dividends?
Dividends are certain, stock price is uncertain, thus dividend paying firms are worth more

However, why would you hold stocks if you dont think it will increase

36
Q

What is the problem with dividend capture and tax

A

Tax rates are not certain and differ between individuals

37
Q

How do you calculate the effective dividend tax rate?

A

(Pcum-Pex)(1-Tg)=D(1-Td)
The after tax price change must equal the taxed dividend

(Pcum-Pex)=D(1-(Td-Tg)/(1-Tg))

The final term is the effective tax rate

38
Q

What is the effective tax rate dependant upon?

A

Income level
Investment Horizon
Tax jurisdiction
Investor type

39
Q

What is the clientele effect? What is the dividend capture theory?

A

A firms dividend stratergy reflects its investors preference

In the absence of transaction costs, firms about to pay special dividends are traded from high income to low income investors on the ex dividend date

40
Q

Discuss cash retention

A

In perfect markets, firms can retain cash

In imperfect markets, a trade off exists between reducing the costs of future capital, bankruptcy and taxes

41
Q

What is FCF Theory?

A

Pay out to avoid manager wasting

42
Q

How can you signal with payout policy?

A

Dividend smoothing

Share repurchases

Stock splits

Spin offs

43
Q

Discuss Mergers

A

Horizontal, Vertical, Congolmerate

Either Stock purchase or asset purchase paid by cash or securities

Can be hostile or friendly

44
Q

What are the motives for mergers?

A

Create Value
Synergy
Growth
Market power

Cross Border
Enter new markets
Exploit legislation

Dubious
Diversification
Wasteful manager

45
Q

What is a leverage buyout?

A

Investors take on debt to purchase all of a firms equity

Will improve then IPO

46
Q

What are the benefits and costs of a LBO

A

To owners: Assets price will increase
To purchasesers: Create new value, tax shield

Costs: Increased probabiltiy of distress,

47
Q

What is a leveraged recapitalisation?

A

A buyback with leverage to increase tax shield

48
Q

What are dual class share issues?

A

Issue a second class of shares with no voiting rights to consolidate decision making

49
Q

What is a spin off

A

Create a new company from part of the firm, equity holders are given new shares.

Why?
Avoid costs associated with sale

50
Q

What is a diverstiture?

A

Sell assets to other corporations

Allows focus on core business

51
Q

What is an equity carvout

A

Sell a percentage of a subsiduary, so remain some of it

52
Q

What are the types of inital funding?

A 
Owner capital
Venture Capital
Institutional Investors
Corporate Investors
Private equity firms
53
Q

What is a venture capital firm?

A

Small business investment companies - Gov Supported Loans

Venture Capital Trusts

54
Q

Discuss venture capital trusts?

A

Large trusts with tax benefits for investment in small firms

Must have 70% in qualifying companies

55
Q

What is a venture capital limited partnership?

A

Buy in to a partnership that invests ins mall firms

General partner runs firm, providing diversificaiton and expertise

56
Q

What is a post money valuation?

A

Pre money valuation + amount invested

57
Q

Discuss an IPO

A

Primary and Secondary offerings

Lead by an underwriter or a syndicate

58
Q

What are the types of offerings

A

Small firm commitment - Small IPOs

Firm Commitment - Underwriter purchases unsold shares

Auction IPO - Firms who dont need awareness

Direct Listing - Straight to market

59
Q

What are the mechanics of an IPO

A

Registration Statement
Prelimary Prospectus
Final Prospectus

Valued using a road show of book building

60
Q

How do you price a deal and manage risk?

A

Underwriters command high fees as firm commitment is very risky

IPO are often underpriced

Greenshoeing is where an underwriter is allowed to sell additional stock at a later date if necessary

61
Q

Why are IPOs underpriced

A

Reduce risk

Signalling

62
Q

What are the types of SEO

A

Cash offer - New stock

Rights offer - Offered to current investors firm to prevent dilution

FTCP (2 decks)

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