CFA II Corp Finance

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CFA II Corp Finance
2013-03-09 16:22:55
CFA II Corp Finance

CFA II Corp Finance
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  1. Calculate 3 parts to project cash flows
    Initial outlay: FCInv (fixed cost investment) + change in NWC (net working capital)

    After Tax Operating Cash Flows: (Rev - Exp)*(1-tax) + Depreciation*tax. Depr*tax = tax shield

    Terminal year cash flow: Salvage + Reverse of NWC change + (Sal - Book)*tax
  2. How to account for inflation in project evaluation
    Inflation should be included in the discount rate. If the rate is nominal, then cash flows should be nominal
  3. Compare mutually exclusive projects with unequal lives
    • LCM: repeat each project to the least common multiple of the lives, and compare. Ex. 3 year and 6 year project
    • 3 year value = NPV + NPV/(1+r)^3
    • 6 year value = NPV

    EAA: Equivalent annual annuity - turn each project into an annuity with no initial outlay equal payments, then compare the payments.
  4. Economic income
    After tax operating cash flow minus economic depreciation

    economic depreciation = discounted before tax cash flows at beginning of period - discounted before tax cash flows at end of period. 

    annual economic income/beginning market value = discount rate
  5. Accounting income
    calculated same as net income on a financial statement
  6. Economic profit, market value added
    net operating profit after tax (NOPAT) - $WACC

    Discount economic profit back to year 0 at WACC to get market value added
  7. Residual income
    Values the firm from an equity perspective, not a project

    residual income = NI - equity charge

    equity charge = required return on equity*beginning book value of equity
  8. Claims valuation approach
    Values the firm, not a project

    CF to debt: Discount CF to debt holders (P&I) at cost of debt

    CF to equity: Discount CF to equity holders (dividends and share repurchases) at cost of equity

    Add CF to debt and CF to equity to get firm value
  9. Calculate WACC
  10. MM proposal 1, no taxes
    MM proposal 2, no taxes
    MM proposal 1, taxes
    MM proposal 2, taxes
    • MM 1, no taxes: , capital structure is irrelevant
    • MM 2, no taxes: WACC is unaffected by amount of leverage
    • MM 1, taxes: , due to tax shield, 100% debt is best
    • MM 2, taxes: 100% debt creates lowest WACC
  11. Signaling: debt offering vs stock offering
    • Debt: positive, firm is levering up
    • Stock: negative, diluting ownership
  12. pecking order theory
    • capital raised based on the following preference order:
    • internal equity
    • debt
    • external equity
  13. static trade off theory
    eventually cost of financial distress out
  14. Change in stock price due to the announcement of a dividend
    Based on clientele effect

    change in price = 
  15. Dividend taxation options
    Double taxation: firm pays taxes on income, then individual pays taxes in dividend income

    split rate system: firm pays higher rate on earnings kept as RE vs earnings payed as dividends

    imputation system: individual receiving dividends pays his income tax on them after adjusting for firm tax rate. Ex. firm pays 20% tax, individual is in 25% bracket, individual will pay 5% tax on dividend. If firm pays 20% tax, individual in 15% tax bracket, individual will receive tax credit worth 5% of dividend.
  16. stable vs constant dividend policy
    • stable: ex. always $1 per share
    • constant: ex. 5% of earnings
    • residual dividend: dividends = NI - funds needed for firm capital (can be short term or long term). ex. target debt/equity = 1, and firm needs 100 in capital next year, so need 50 in equity and 50 in debt. if NI = 60, keep 50 for capital and pay 10 in dividend.
  17. Value of share repurchase vs dividend
    Same if no taxes.

    if tax on dividends is higher than cap gains, repurchase is better

    repurchase can also be a positive signal
  18. dividend payout ratio
    dividend coverage ratio
    FCFE coverage ratio
    • Div/NI
    • NI/Div
    • FCFE/(Div + share repurchases), where FCFE = CFO - CapEx + Net Borrowings
  19. acquisition vs merger
    • acquisition: buy part of company
    • merger: buy entire company
  20. Statutory merger, subsidiary merger, consolidation
    • statutory: acquirer buys all of target's assets and liabilities, target no longer exists. Does not necessarily buy the firm (may not want something to do with company, like an environmental issue)
    • subsidiary: target continues to exist, usually due to strong brand name
    • consolidation: merger creates new firm, neither acquirer nor target continues to exist. New firm may have same name as one of the others.
  21. conglomerate merger
    two companies from completely different industries merge
  22. poison pill (flip-in, flip-out), poison put
    • poison pill: shareholders have right to purchase additional shares at a discount
    •   flip-in: discount for purchase of target's shares
    •   flip-out: discount for purchase of acquirer's shares
    • poison put: bondholders can demand repayment in event of takeover
  23. fair price amendment, golden parachutes
    • fair price: requires shareholders to be offered "fair price" for shares based on independent appraisal
    • golden parachutes: if takeover, managers receive lucrative cash payouts 
  24. greenmail, share repurchase, leveraged recapitalization, crown jewel, pacman defense, white knight defense, white squire defense
    • greenmail: ex. acquirer buys 10% of target in attempt to takeover. target buys back shares from acquirer for premium and acquirer signs agreement to stop takeover attempt
    • share repurchase: target submits offer for own shares to shareholders
    • recapitalization: issue debt to buy shares, lever up
    • crown jewel: get rid of valuable asset that acquirer wants
    • pacman defense: target turns around and tries to buy acquirer
    • white knight: find friendly acquirer to buy firm
    • white squire: find party to buy large stake and block takeover attempt
  25. HHI index calculation and way to determine if merger is anti-competitive
    • HHI = sum(market share each firm)^2
    • ex. 2 firms: 50% each. HHI = 50^2 + 50^2 = 5000

    • HHI < 1000 = not concentrated
    • 1000 < HHI < 1800 = moderate concentration
    • HHI > 1800 = highly conentrated

    If moderate concentrated and merger causes an increase of more than 100, may be regulatory scrutiny. If high concentration and increase of more than 50, will probably be regulatory scrutiny. If HHI < 1000 after merger, probably won't be any scrutiny.
  26. FCFF from NI
    FCFE from CFO
    FCFF = NI + non cash charges - change in working capital + interest*(1-tax) - capex

    FCFE = CFO + net borrowing - capex
  27. Post merger value of acquirer, gain to target, gain to acquirer. What is price paid in stock transaction?
    a = acquirer, t = target

    Vat = Va + Vt + synergies - cash paid to t's shareholders

    Gt = transaction premium = price paid for target - Vt

    Ga = Synergies - transaction premium

    Price paid for stock merger = number of shares*price of new company after the merger