4104 final

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  1. This tax savings will increase the value of a firm that uses share repurchases rather than dividends when …

    tax for dividend is higher than tax for capital gain

  2. While an increase of a firm’s dividend may signal management’s optimism regarding its future cash flows, it might also signal ….

    a lack of investment opportunities.

  3. Share repurchases are a credible signal that the shares are under-priced, because if…

    they are over-priced a share repurchase is costly for current shareholders.

  4. RLA =…

    CFE + CFD / D+E

  5. …does not change with leverage but …changes

    RA, RLA

  6. Return(x) = …

    CF/x value

  7. RG always equal RE because …

    they have the same risk

  8. With partial debt financing, NPV for E = …

    PV(project) -D –[cost(project) –debt]

  9. Tax value = …

    A – E –D

  10. FCF = …

    (revenue – costs – depreciation) *(1-tax%) + depreciation- capex – Change(NWC)

  11. Efficient Markets Hypothesis- Implies that securities will be…, based on their future cash flows, given all information that is available to investors. Weak form efficiency- It is impossible to consistently profit by trading on information in ….Semi-strong form efficiency - It is impossible to consistently profit by trading on any …

    fairly priced; past prices; public information

  12. New debt issuance - When a firm increases its leverage, if its existing debt holders do not have a senior claim in the event of bankruptcy, a new debt issue can ….the value of existing debt. The loss to the old debt holder is transferred to a gain to the …holders.

    Decrease; equity

  13. asset substitution problem - Debt financing forces the firm to give up a good project and undertakes a bad project. It forms the…., borne by…. Hence debt financing wastes resources and is socially un-optimal in this case.

    indirect cost of debt; equity holders

  14. Debt overhang problem - Equity holders may underinvest – that is, …investments because …and the higher interest rate is borne by …

    pass up profitable (positive NPV); the firm’s existing debt captures most of the project’s NPV; equity

  15. Disadvantage of incentive:

    • a) Stock price is only a noisy measure of performance
    • b) Compensation awards the good but doesn’t punish the bad, which leads the mangers to take higher risk.
    • c) Compensation is expensive.

  16. M&A - Bidding firm is…; targeted firm is...

    Overvalued, under-valued

  17. Free-rider problem in takeovers- Small shareholders will not tender their shares if…. As a result, takeovers that could potentially lead to substantial value improvement may fail.

    they are offered less than the post-takeover value of the shares

  18. Asymmetric information - Managers who perceive the firm’s equity is underpriced will have a preference to fund investment using…, rather than equity. Issue of equity signal that…. For outside equity financing, …is better than least cost separating equilibrium. For debt financing, only …is possible. Information asymmetry can cause social inefficiency.(good projects passed up and bad projects taken) Debt financing is less …than equity financing, and hence debt financing is better in mitigating the inefficiency of information asymmetry than equity. Information asymmetry leads to wealth reallocation: …

    retained earnings, or debt; the firm is bad; pooling equilibrium; separating equilibrium; information-sensitive; decreases NPV of good firm and increases NPV for bad firm.

  19. Moral hazard – outside equity financing, manager always …because he gets higher NPV when shirk, regardless of investors’ belief; outside debt financing, manages will ….(thus the face value of debt); hence debt financing is better to mitigate the market friction of moral hazard, given the cost of effort(requirement: working hard payoff > shirk payoff), sometimes both may mitigate

    Shirk; work according to investors’ belief

  20. 2 irrelevance- In a frictionless market, ie. in the absence of tax and transaction costs…

    • the choice between paying dividends and repurchasing shares is a matter of indifference to shareholders
    • if the investment decision is given, it doesn’t matter how much dividend to pay out.

  21. Mm1

    MM1 is that financing decision is irrelevant to the cash flows generated by asset

  22. Mm2

    Expected return of firm's equity increases as the firm's leverage ratio increases

  23. Explain the RA, RE and RD VS leverage
    RD increases after debt becomes risky

    RE increases with D/E because E becomes more risky

    rate of increase of RE decrease after debt becomes risky – equity transfer risk to debt
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4104 final
2015-05-27 16:34:26
4104 final

4104 final
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