CFA 5

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CFA 5
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2011-05-16 23:27:52
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CFA 5
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  1. 3 measures for economic activity
    • 1) GDP-total goods produced in country boundaries
    • 2) GNI - produced by residents of country, gross national income
    • 3) NNI - GNI less depreciation, most accurate

    • GDP
    • +Net property income from abroad
    • =GNI
    • -depreciation
    • =NNI
  2. cost of goods sold equ
    begin inv + purchases - end inv = COGS
  3. FIFO
    LIFO
    AVG Cost
    Specific Indentification

    -description, End inv, COGS
    Specific indentifcation: actual cost of specific items included in end inv

    • HIGHEST -----> Lowest
    • End Inv: Fifo, Avg Cost, LIFO
    • COGS: LIFO, AVG, FIFO
  4. period system vs. perpetual system
    inventory/cogs determined at end of period or continuously updated
  5. Balance sheet Lifo to Fifo equs (3)

    Inventory
    Cash
    Equity
    InventoryFIFO=InventoryLIFO + LIFO Reserve

    • CashFIFO=CashLIFO-(Reserve x tax rate)
    • EquityFIFO=EquityLIFO+[reserve x (1-t)]
  6. income statement, lifo to fifo
    COGS
    Taxes
    NI
    COGSFIFO = COGSLIFO - change in reserve

    • TaxesFIFO = TaxesLIFO+Change in resrve x tax rate)
    • NIFIFO = NILIFO + [change in reserve x (1-t)]
  7. assuming rising costs, FIFO affect on

    current ratio
    Inventory turnover
    long-term debt-to-equity
    gross/net profit
    CA/CL ->higher inventory is partially offset by lower cash from taes

    Lower COGS/Avg inv, lower COGS and higher inv

    lower, higher equity from LIFo reserve net of tax

    higher profits - lower COGS, profits partially offset by higher taxes
  8. explain
    increase in raw materials and WIP

    increase in finished goods alone

    finished goods growing faster than sales
    expected increase in demand

    decrease in demnad

    decrease in demand, may be the result of exeessive or obsolete inventory
  9. capitalize vs. expensing

    general rule and def
    capitalize if there is a future economic benefit, immeditely expense if the future benefit is unlikely or uncertain

    Capitalizing: involves depreciating asset's cost over its useful life

    expensing: results in an immediate reduction of net income
  10. Where to report:
    Capatialized interest
    Interest expense
    • CFI
    • CFO
  11. 6 analysis adjustments to adjust out effects of capitalization
    • 1) add capitalized interest to interest expense
    • 2) remove depreciation of CI from earnings
    • 3) deduct CI net of related depreciation from fixed assets
    • 4) add CI to CFI
    • 5) deduct CI from CFO
    • 6) recalc interest coverage and profitability ratios
  12. research and devleopment costs

    IFRS vs GAAP
    IFRS: resarch costs are expense as incurred but development costs are capitalized

    GAAP: R&D costs are expensed as incurred
  13. software development costs
    IFRS vs gaap
    internal vs for sale
    • For sale:
    • IFRS/GAAP: expensed as incurred until feasibility is reached

    • InternaL:
    • IFRS: same as software developed for sale
    • GAAP: capitalize all software development costs
  14. straight-line depreciation

    double-declining balance

    Units of production
    equs
    SL= (Cost-salvage value) / useful life

    DDB (Cost - Acc Depn) x (2/useful life)

    UOP = (Cost - Salvage value) x (unis used/ total capacity)
  15. impairment (IFRS)
    asset is imparied when book value (historical cost - acc. deprec) > recoverable amount

    recoverable amount is greater of "fair value less selling costs" and "value in use"

    • if impaired:
    • -write-down asset to recoverable amount and recognize loss in I.S.
    • -loss reversal is allowed up to original loss
  16. impairment (GAAP)
    1)identify impariemnt-impaired when book value > asset's estimated future undiscounted cash flows

    2) loss recognition - if impaired, write down to fair value and put loss on I.S.

    -loss reversal is prohibited for assets "held-for-use"
  17. impact of impariment on

    BS
    IS
    CF
    Disclosure
    BS: reduces assets, liabilities (deferred taxes), and S.E.

    IS: loss decreases current period net income; in future periods, reduced deprec. results in higher net income

    CF: unaffected

    Disclosure: MD&A, footnotes
  18. impact of impairment on ratios

    1) fixed asset and total asset turnover ratios
    2)debt-to-equity ratio
    3) current year ROA and ROE
    4) future ROA and ROE
    1) fixed asset and total asset turnover ratios: increase due to reduced assets

    2)debt-to-equity ratio: increases due to reduced equity

    3) current year ROA and ROE: decrease, % reduction in net income > % reduction in Assets/equity

    4) future ROA and ROE: increase due to lower assets and equity, higher net income with lower depreciation
  19. asset revaluation (gaap vs. ifrs)
    • GAAP: depreciated historic cost
    • IFRS: depcreciated historic cost or fair value
  20. estimated useful life equ
    historical cost/ annual depn
  21. Estimated age
    accum depn/annual depn
  22. Estimated remaiing life
    Net Book Value / Annual Depn
  23. GAAP, treat as finance lease if any of the following is met (4)
    1) title to the leased asset is transferred to the lessee at the end of the lease

    2) a bargain purchase option exists

    3) the lease term is >75% of the asset's economic life

    4) the PV of the lease payments >90% of the leased asset's fair value
  24. finance lease
    Treat as if leased asset was purchased with debt

    Lower of fair value or PV of future lease payments reported as balance sheet ASSET AND LIABILITY

    depreciated over time

    interest expense is recognied on liability

    lease payments treated like amortizing debt - each payment is part interest (CFO) and part principal (CFF)
  25. lessor financial reporting

    Finance vs. operating
    • finance:
    • -lessor reports lease receivable on BS
    • -treat as either sale-type lease or direct-financing lease

    • operating:
    • -lessor reports leased asset on bs
    • depreciation expense on asset
    • lease payments as rental income
  26. sale type lease (def)
    lessor is typically a dealer or the asset

    PV of lease payments > carrying value of leased asset
  27. direct financing lease
    lessor is not the dealer

    PV of lease payments = carrying value of leased asset
  28. percentage ownership

    4
    financial assets <20%

    • investments in associates 20-50%
    • -equity method

    • Busines combinations >50%
    • -acquisition method

    • shared control by 2+= joint venture
    • -IFRS: proportionate consolidation
    • -GAAP: equity method
  29. joint venture (gaap vs. IFRS)
    GAAP: Equity

    IFRS: proportionate consolidation or equity
  30. Held to maturity

    def, initially reported?
    • debt securities where the company has the intent and ability to hold to maturity
    • Initially reported:
    • GAAP: cost including transaction costs
    • IFRS: Fair value including tranasction costs
    • COST METHOD
  31. held for trading
    debt and equity securities acquired for the purpose of selling in the near future

    MARKET METHOD
  32. available for sale
    debt and equity that are neither held-to-maturity nor trading securities

    HYBRID
  33. Designated at fair value
    management has the option to report held-to-maturity or available-for-sale assets at fair value

    treated like Held-for-trading
  34. Available for sale (IFRS)
    FX gains and losses on debt to income statement in IFRS not GAAP
  35. investments in associates: equity method

    BS, IS,
    balance sheet: reported at cost + earnings - dividents

    IS: earnings
  36. evidence of significant influence (5)
    • representation on board of directors
    • participation in policy making
    • material transactions between the parties
    • interchange of key personnel
    • technological dependency

    Influence: finance, operating, amount and timing of dividends
  37. equity method impairment
    fair value < carrying value AND deemed to be permanent

    asset written down to fair value and impariemnt loss on IS

    no reversal in GAAP or IFRS
  38. intercompany transfers
    upstream profit on transaction in associates accounts (Dunder Mifflin sells paper to Sabre)

    downstream profit on transaction in parent's accounts (sabre sells printers to Dunder mifflin)

    both must eliminate proportionate share of profit from equity income
  39. 6 steps of acquisition method
    1) elminate investment account of parent and equity accounts of subsidiary

    2) create minority interest (share of equity not owned)

    3) combine assets and liabilities of both firms (net of intercompany transactions)

    4) eliminate subsidiary earnings from parent

    5) subtract minority share of earnings (share of earnings not owned)

    6) combine revenues and expenses of both firms (net of intercompany transactions)
  40. joint venture accounting and 3 issues
    equity method for GAAP

    • 1) net profit margin overstated
    • 2) ROA overstated
    • 3) debt ratios skewed
  41. IFRS 3 types of JV
    • 1) jointly controlled entities: sharing control of a separate entity
    • 2) jointly controlled operations: each venture uses its own assets for a shared project
    • 3) jointly controlled assets: a project carried out with assets that are jointly owned
  42. parital vs. full goodwill
    • GAAP requires full
    • IFRS allwos bowth

    full goodwill = total fair value of subsidiary minus FV of net identifiable assets

    Partial: goodwill is purchase price, minus the % owned times fair value of net identifiable assets
  43. 3 step process for impairment of goodwill (IFRS and GAAP)
    • 1)
    • IFRS: allocated across cash generating units that will benefit from acquisition
    • GAAP: Allocated across reporting units: operating segment or component

    • 2)
    • IFRS: One-step process
    • -if recoverable amount < carrying value, recognize difference as impairment

    • GAAP: 2-step process
    • -if fair value of reporting unit < carrying value, goodwill is impaired
    • -amount of impairment is unit's reported goodwill - current fair value of unit's goodwill

    • 3)
    • IFRS: if loss is greater than unit goodwill, remainder is allocated to impairment of other assets of the cash generating assets

    GAAP: If loss is greater than the current fair value of a unit goodwill, unit goodwill is reduced to zero, no other allocation of impairment amount


  44. EQUITY METHOD = best ratios
  45. DC accounting

    IS, BS
    IS = employer contribution

    BS = asset/liability = excess or shortfall in payments relative to specified contribution

    no issues for analyst
  46. Pay-related plans
    pension benefits are based on future compensation
  47. PBO
    ABO
    VBO
    IAS 19
    PBO: projected benefit obligation: PV of all future pension payments earned to date based on expected salary increases overtime. Going concern basis

    ABO, accumulated benefit obligation: PV of all future pension payments earned to date based on current salary levels, liability on liquidation basis

    Vested benefit obligation: only vested units

    IAS 19: a measure of Defined benefit obligation similar to PBO
  48. PBO Components
    Service Cost
    Interest Cost
    Actuarial G/L
    Prior Service costs
    Benefits paid
    SC: change in PBO attributed to employees efforts during the year. The actuarial PV of pension benefits earned in a year

    IC: increase in the PBO resulting from passage of time: PBO at start of period x discount rate

    Actuarial g/l: g/l resulting from changes in actuarial assumptions

    Prior service costs: retroactive benefits awarded to employees

    Benefits paid: payments made from the fund to retirees
  49. PBO equ (6)
    • Beninning PBO
    • +Service Cost
    • +Interest Cost
    • +/- Actuarial g/l
    • + prior service cost
    • - benefits paid
    • ________
    • Ending PBO
  50. Fair value of plan assets (equ 4)
    • Fair value at start of year
    • +/- actual return on plan assets
    • + Employer contributions
    • - benefits paid to retirees
    • ______
    • fair value of plan asset at year end
  51. Pension expense on income statement (6)
    • Net period benefit costs
    • +service costs
    • + interest costs
    • -expected return on plan assets
    • +/- amortization of g/l
    • + amortization of prior service costs
    • +/- amortization of transition (asset)/liability
    • ___________
    • Pension expense on IS
  52. all plans make/disclose 3 assumptions
    • 1) discount rate
    • 2) expected return on plan assets
    • 3) rate of compensation increase
  53. these assumptions can affect:
    • balance sheet (through effect on PBO)
    • disclosures (ABO, VBO)
    • income statement (pension cost)
  54. IAS 19 allows for delayed recognition of certain events (2)
    • 1) deferred g/l
    • -from changes in actuarial assumptions affecting the PBO
    • -from differences in the actual and expected return on plan assets

    • 2) trasition assets and liabilities
    • -artifact of implementation of new accounting rule in 1985
  55. Balance Sheet (IAS)
    • Funded status: +overfunded -underfunded
    • Deferred (gain)/loss +/-
    • Transition (asset)/liab +/-
    • ___________

    Balance sheet (liability)/asset
  56. toatl Income statement efect equ
    Total IS effect = service + interest - actual return
  57. economic pension expense (Equ)

    6
    • Ending PBO
    • -Beginning PBO
    • =Change in PBO
    • +benefits paid
    • -actual return on assets
    • =Economic pension expense
  58. Contribution > economic expense
    <?
    • > : principal payment
    • CFO up, CFF down

    < : borrowing
  59. 6 inputs to option pricing models
    • 1) exercise price
    • 2) stock price at the grant date
    • 3) expected term
    • 4) expected volatility
    • 5) expected dividends
    • 6) risk-free rate
  60. Translation/Current Rate Method
    Remeaseurement/Temporal Method
    Current Rate/Temporal method

    Local Currency to Functional Currency to Presentation currency (Picture)
  61. 5 factors to consider in deciding functional currency
    1) currency that influences sales prices for goods and services

    2) currency of the country that determines prices

    3) currency that influences labor, material and costs

    4) currency form in which funds are generated

    5) currency which reciepts from operating activities are usually retained
  62. EXCHANGE RATE DEFS
    current rate

    average rate

    historical rate
    current: exchange rate on the balance sheet date

    avg: average over period

    historical rate: actual rate during transaction
  63. hyperinflationary enviroment
    where cumulative inflation exceeds 100% over a 3-year period
  64. fair value hedge
    purpose and recognition
    purpose: offset exposure to changes in fiar value of an asset/liab

    recog: gains and losses are recognized in the IS
  65. cash flow hedge

    purpose and recognition
    offset exposure to variable cashflows from anticipated transactions

    G/L report in equity. The gains and losses are eventually recognized in the IS
  66. net investment hedge of a foreign subsidiary

    purpose and recognition
    offest exposure from an existing investment in a foreign sub

    g/L are recognized in equity along with translation g/l
  67. 6 mechanisms to deter strategic manipulation
    • 1) indepedent audit
    • 2) board of diretors
    • 3) certification by senior management
    • 4) class action litigation
  68. formula for balance sheet based aggregate accruals
    accrualsBS = NOAEND - NOABEG
  69. accruals ratioBS equ
    accruals ratioBS=[(NOAend-NOAbeg)]/[(NOAend+NOAbeg)/2]
  70. accruals cash flow equ
    accrualsCF = NI - CFO - CFI
  71. accruals ratio cash flow
    accrualsCF =

    [NI - CFO - CFI] / [(NOAEND+NOABEG)/2]
  72. core operating margin equ
    (sales - COGS - SG&A) / sales
  73. categories of capital budge projects (6)
    • 1) replacement projects to maintain the business
    • 2) replacement projects for cost reduction
    • 3) expansion projects
    • 4) new product or market development
    • 5) mandatory
    • 6) other
  74. 5 principals of capital budgeting
    • 1) decisions are based on cash flows, not accounting income
    • 2) cash flows are based on opportunity costs
    • 3)timing of cash flows is important
    • 4) cash flows are analyzed on an after-tax basis
    • 5) financing costs are reflected in the project's required rate of return
  75. MACRS
    Modified accelerated cost recovery system
    DEF
    for capital budgeting purposes, we should use the same depreciation method used for tax reporting since captial budgeting analysis is based on after-tax cash flows and not accounting income
  76. initial investment outlay equ
    outlay = FCInv + NWCInv

    NWCInv = change in non-cash current assets - change in non-debt current liab = change in NWC
  77. after tax operating cash flows
    CF = (S-C)(1-T)+(TD)

    • S = sales
    • C = cash operating costs
    • D = depreciation expense
    • T = Marginal tax rate
  78. terminal year after-tax non-opearting cash flows (TNOCF)
    • TNOCF = SalT + NWCInv - T (SalT-BT)
    • SalT=pre-tax cash proceeds from sale of fixed capital
    • BT = book value of the fixed capital sold
  79. inital outlay if replacement project equ
    outlay = FCInv + NWCInv - Sal0+T(Sal0-B0)
  80. hard capital rationing
    soft capital rationing
    hard: occurs when the funds allocated to managers under the capital budge can't be increasesd

    soft: managers are allowed to incrase their allocated budget if they can justify
  81. simulation analysis (monte carlo)
    results in a probability distribution of project NPV outcomes, rather than just a limited number of outcomes as with sensitivity or scenario analysis.
  82. scenario analysis
    risk analysis technique that considers both the sensitivity of some of key output variable to changes in a key input variable
  83. real options def and 5 examples
    allow managers to make future decisions that change the value of capital budgeting decisions

    • timing
    • abandonment
    • expansion
    • flexibility (price-setting,production)
    • fundamental option (copper mine, open if profitable)
  84. economic income (3 equ)
    economic income = cash flow + ending market value - beginning market value

    economic income = cash flow - economic depreciation

    economic income = beginning market value - ending market value
  85. accounting income def and difference from econonmic (2)
    reported net income on financial statements

    • 1) accounting deprec is based on the orgininal cost
    • 2) financing costs are considered as a separate line item and subtracted out to arrive at net income. in capital budgeting, financing costs are reflected in WACC
  86. economic profit equ
    EP = NOPAT - $WACC

    • NOPAT = net operating profit after tax
    • $WACC = dollar cost of capital = WACC x capital
    • capital = dollar amount of investment
  87. Market value added equ
    NPV = MVA = Sum of [EPt / (1+WACC)t]
  88. residual income
    RIt = NIt - reBt-1

    • RI = residual income in period t
    • NI = net income in period t
    • r = required return on equity
    • B=beginning of period book value of equity
  89. claims valuation approach
    divides operating cash flows based on the claims of deby and equity holders that provide capital to the company

    calculates the value of the company, not the project. this is different from the economic profit and residual income approahes, which calc both project and company value
  90. progession of capital structure theories
    MM 1958: no taxes, no costs of financial distress

    to

    MM 1963: taxes, no costs of financial distress

    to

    Static trade-off theory with taxes and costs of financial distress
  91. MM assumptions 5
    • -capital markets are perfectly competitive
    • -investors have homogeneous expectations
    • -riskless borrowing and lending
    • -no agency costs
    • -investment decisions are unaffected by financing decisions
  92. MM proposition 1 no taxes
    no taxes

    value of levered firm = value of unlevered firm

    capital structure doesn't matter
  93. MM proposition 2 no taxes
    • no taxes
    • cost of equity increases linearly as a company increases its proportion of debt financing
  94. MM proposition 1 with taxes
    tax shield provided by debt

    VL=VU+(t x d)

    optimal structure is 100% debt
  95. MM proposition 2 with taxes
  96. Tax shield causes WACC to decline as leverage increases. the value of the firm is maximized at the point where the WACC in minimized, which is 100% debt
  97. costs of financial distress
    def and 2 components
    increased costs a company faces when earnings decline and the firm has trouble paying its financing costs

    • 1)direct/indirect: direct fees, legal
    • -indirect: lost opportunities

    2)probability of financial distress: use of leverage
  98. agency costs of equity (def and 3 components)
    costs associated with the conflicts of interest between managers and owners

    • 1) monitoring costs
    • 2) bonding costs (non-competes, etc)
    • 3) residual losses
  99. pecking porder theory

    def and 3
    signals management sends to investors through financing

    • most favored to least favored
    • -internally generated equity
    • -debt
    • -external equity
  100. static trade-off theory def and equ
    seeks to balance the costs of financial distress with the tax shield benfits from using debt

    VL=VU +(t x d)-PV(costs of financial distress)
  101. 3 things analyst hould look at regarding capital structure
    • 1) changes in structure over time
    • 2) relative to competitors with similar business risk
    • 3) company-specific factors
  102. 3 international differences in financial leverage
    • 1) total debt
    • 2) debt maturity
    • 3) emerging market difference

  103. longer, or shorter
  104. change in price from losing dividend (equ)
    change in P = [D(1-TD)] / (1-TCG)
  105. 6 factors that affect firm dividend payout policy
    • 1) investment opportunities
    • 2) expected volatility of future earnings
    • 3) financial flexibility
    • 4) tax considerations
    • 5) flotation csots
    • 6) contractual /legal restrictions
  106. effective tax rate equ
    effective tax rate = corporate tax rate + (1-corporate tax rate)(individual tax rate)

    double taxation
  107. split-rate tax system
    earnings distributed as dividends are taxed at a lower rate
  108. imputation tax system
    taxes paid at corporate level but are attributed to the shareholder, so all taxes are effectively paid at the shareholder rate
  109. expected dividend equ
    previous dividend + expected increase in EPS x target ratio ratio x adjustment factor

    adjustment = 1/number of years which the adjustment in dividends will take place
  110. residual dividend model
    dividends are based on earnings less funds the firm retains to finance the equity portion of its capital budget
  111. 5 common rationales for share repurchases
    • 1) potential tax advantages
    • 2) share price support/signaling
    • 3) added flexibility
    • 4) offsetting dilution from employee stock options
    • 5) increasing financial leverage
  112. 3 generalization made to global trends in dividend policies
    1) lower proportion of US companies pay dividends as compared to europeans

    2) proportion of firms paying cash dividends has trended downward

    3) % of companies making stock repurchases has been trending upwards
  113. FCFE coverage ratio equ
    FCFE coverage ratio - FCFE / (Dividends + share repurchases)
  114. corporate governance def
    the system of principles, policies, procedures, and cleraly defined responsibilities and accountabilities used by stakeholders to overcome conflicts of interest inherent in the corporate form
  115. 2 major objectives of corp gov
    • 1) eliminate or reduce conflicts of interets
    • 2) use the company's assets in a manner consistent with the best interests of investors and other stakeholders
  116. sole proprietorships def and conflict
    businesses owned by a single individual

    conflicts between creditors and suppliers
  117. partners, def and conflict
    2 or more owners/managers

    creditors and supplires, potential conflicts between partners, can be addresssed by delineating rolse and responsibilities
  118. corporations, def and conflicts
    • distrinct legal entities that have rihgts similar to those of an individual
    • -easier to raise capital
    • -ownership is transferable
    • -limited liability

    conflicts: agency. conflict between shareholders and management
  119. issues between managers and shareholders (4)
    using funds to expand the size of the firm

    granting excessive comp and perquisites

    investing in risky ventures

    not taking enough risk
  120. issues between directors and shareholders (5)
    lack of independence

    board members have personal relationships with management

    board members have consulting agreements with firm

    interlinked boards

    directors are overcompensated
  121. 7 things that analyst should assess about corp gov
    • 1) code of ethics
    • 2) directors' oversight/review responsibliities
    • 3) management's responsibility to the board
    • 4) reports of directors' oversign
    • 5) board self assessments
    • 6) management performance assessments
    • 7) director training
  122. weak corp governance does 5 things
    1) lowers value of company by increasing risks

    2) financial disclosure risk

    3) asset risk

    4) liability risk

    5) strategic policy risk
  123. statutory merger
    acquiring company acquires all the target's assets and liabilities
  124. subsidiary merger
    company becomes a subsidiary of the purchaser
  125. consolidation
    both companies cease to exist in their prior form
  126. horizontal merger
    two businesses operate in the same industries/competitors
  127. vertical merger
    acquiring company seeks to move up or down the product value chain. ice cream manufactuere acquires restaurant chain
  128. conglomerate merger
    2 companies operate in completely separate industries
  129. bootstrapping
    way of packaging the combined earnings from two companies after a merger so that the merger generates an increase in the earnings per share
  130. stock purchase vs. asset purchase
    -payment
    -approval
    -corp taxes
    -shareholder taxes
    -liabilities
    • stock
    • -made directly to target company shareholders in exchange for their shares
    • -majority shareholder approval required
    • -none
    • -shareholdres pay capital gains tax
    • -acquirer assumes liabilities of target

    • asset purchase
    • -made directly to target company
    • -no approval needed
    • -target company pays capital gains taxes
    • -none
    • -acquirer usually avoids assumption of target's liabilities
  131. 3 factors in choosing method of payment
    1) distribution between risk and reward for the acquirer and target shareholders

    2) relative valuations of companies involved

    3) changes in capital structure
  132. Pre-offer defence mechanism: poison pill
    gives current shareholders right to purchase additional shares at low prices
  133. Pre-offer defence mechanism:poison put
    focus on bondholders, puts give bondholders ths option to demand immediate repayment of their bonds if there is a hostile takeover
  134. Pre-offer defence mechanism: staggered board
    board split into 3 equal sized groups with staggered election
  135. Pre-offer defence mechanism: restricted voting rights
    equity ownership above x% triggers loss of voting rights unless approved by board
  136. Pre-offer defence mechanism: supermajority voting provisions for mergers
    increases majority to 66% or greater
  137. Pre-offer defence mechanism: fair price amendment
    restricts merger offer unless fair, as determined by some formula
  138. Pre-offer defence mechanism: golden parachutes
    gives managers lucrative cash payouts if they leave the target company after a merger
  139. post-offer defence mechanisms: greemail
    payoff to potential acquirer to terminate the hostile takeover attempt
  140. post-offer defence mechanisms: leverage recapitalization
    target assumes a large amount of debt that is used to finance share repurchases
  141. post-offer defence mechanisms:
    -crown jewel defense
    -pac-man defense
    -white knight
    -white squire
    • -target sell a major asset to 3rd party
    • -try to acquire the acquirer
    • -3rd party comes to counter bid
    • -3rd party buys minority stake
  142. summarize U.S. antitrust litigation (4)
    1890: The sherman antitrust act: made monopoly illegal, not enforceable

    1914: The Clayton Antitrust Act: created FTC to enforce

    1950: the Celler-Kefauver Act: addressed weaknesses in 1914 act

    1976: the Hart-Scott-Rodino Antitrust: required all potentail mergers to be reviewed and approved by FTC
  143. HHI
    HHI = sum of (MSi x 100)2

    MSi=market share of firm i
  144. find FCF using DCF 6 steps
    • 1) determine which cash flow model to use
    • -2, 3 stage, etc

    • 2) develop pro-forma financial estimates
    • 3) calculate free cash flows using the pro forma data
    • 4) discount CFs back to present
    • 5) determine terminal value and discount back
    • 6) add the FCF for the first stage and terminal value to determine final value
  145. net income to FCF equ
    • Net Income
    • +Net Interest after tax
    • =Unlevered net income

    • +_ change in deferred taxes
    • =NOPLAT
    • +net noncash charges
    • +_change in NWC
    • - capital expenditures
    • =FCF

    NWC = current assets - current liabN

    et interest after tax = (interest expense - interest income) * (1-t)
  146. Terminal value EQU
    terminal valueT = [FCFT*(1+g)] / (WACCadjusted - g)
  147. 5 steps to comparable company analysis
    • 1) find comp firms
    • 2) calc multiples
    • 3) calc descriptive stats and apply to firm
    • 4) estimate takeover premium
    • 5) calc the estimated takeover price for the target as the sume of estimated stock value based on comps and takeover premium
  148. takeover premium equ
    TP = (DP - SP) / SP

    • TP = takeover premium
    • DP = deal price per share
    • SP = target co's stock price
  149. 3 steps comparable transaction analysis
    1: identify a set of recent takeover transactions

    2: calc various relative value measures based on completed deal prices for the companies in the sample

    3: calc descriptive stats for the relative value metrics and apply those measures to the target firm
  150. post-value of an acquirer (equ)
    VAT=VA+VT+S-C

    • A: acquirer
    • T: Target
    • S=synergies
    • C=cash paid to target shareholders
  151. gain accrued to the target (equ)
    • GainT=TP=PT-VT
    • TP: takeover premium
    • P= price paid for target
    • V=pre-merger value of target
  152. gains accrued to the acquirer (equ)
    • GainA=S-TP=S-(PT-VT)
    • synergies - takeover price
  153. who assumes risk?

    cash offer
    stock offer
    cash offer: acquirer assumes the risk and potential reward.

    stock offer: some risks shift to target firm
  154. divestitures
    comapny selling a division or subsidiary
  155. equity carve-outs
    create a new independent company by giving equity interest in a subsidiary to outside shareholders
  156. spin-offs
    like carve-outs in that they create a new independent company that is distinct from the parent company
  157. split ofs
    allow shareholders to receive new shares of a division of the parent comapny in exchange for a portion of their shares in the parent company
  158. liquidations
    break up the firm and sell its asset piece by piece, most associated with bankruptcy
  159. 4 major reasons for divestiture
    • 1) division no longer fits into management's long-term strategy
    • 2) lack of profitability
    • 3) individual parts are worth more than the whole
    • 4) infusion of cash

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