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22 Cards in this Set

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What is the Modigliani-Miller theorem.
The Modigliani-Miller theorem posits that the valuation of a firm is completely independent of its capital structure (whether it is financed through debt, equity, etc.). This theorem assumes that taxes, bankruptcy costs, assymetric information, and market inefficiency are absent.
What is NPV?
Net present value is the sum of the present values of a project or investments annual cash flows minus the initial investment.
The practice of taking advantage of a price differential between two or more markets
Tax shield formula
Tax Shield = t*D

t = corporate tax rate
D = market value of firm's debt
Tax Loss Carry (back/for)ward
Applying net losses to either future or past tax claims. In the USA, up to 3 years back or 5 years forward.
financial distress
An undesirable situation caused by excessive debt, with (theoretically) no effect on cash flows, and thus no effect on value
Real-world effects of financial distress
1) Legal costs in case of bankruptcy
2) Pass up valuable investment projects due to debt overhang
3) Competitors may take opportunity to be aggressive
4) Scare off customers/suppliers
5) In-house morale costs
Recipe for optimal capital structure
Start with M-M irrelevance, then account for taxes and expected distress costs.
Formula for "Expected distress costs"
(Probability of distress) * (Distress costs)
Causes of volatile cash flows
1) Industry change
2) Technology change
3) Cyclical industry
4) Macro shocks
5) Start-up
Agency costs
Costs passed to principals (shareholders) by agents (managers) who act outside the principals' interests. This is reflected by a lowered share price.
Free Cash Flow
Cash flow in excess of that required to fund all positive NPV projects.

FCF = OCF - (dividends + capex)
Leveraged Buyout
A financial sponsor (incumbent management in the case of a Management Buyout [MBO]) gains control of a company's equity with debt financing.
Management Buyout
Incumbent management gains control of a company's equity with debt financing.

1) Increased management interest
2) Increased leverage, demanding greater efficiency
3) Increased debt shield
Sustainable growth rate
The maximum growth rate that a firm can sustain using its own resources and cash flow, without having to increase financial leverage.
Sustainable growth rate (formula)
SGR = (1 - d) * ROE

d = dividends paid
Static Tradeoff Theory
Optimal capital structure represents a trade-off between tax shield of debt and expected costs of financial distress
Pecking Order Hypothesis
Internal funds are used first, and when that is depleted debt is issued, and when it is not sensible to issue any more debt, equity is issued
Information assymetry
When one party (usually management) is privy to more information compared to another party (shareholders)
What can increase a company's SGR?
* Decreased dividends (d)
* Increased Profit Margins (NI/Sales)
* Increased Asset Turnover (Sales/Assets)
* Increased leverage (Assets/NW)
Ways to report dividends
* Dividends per share (dollars/share)
* Dividend yield (DPS/share price)
* Payout ratio (DPS/EPS)
Dutch auction share repurchase
specifies a price range within which the shares will ultimately be purchased. Shareholders are invited to tender their stock, if they desire, at any price within the stated range. The firm then compiles these responses, creating a supply curve for the stock.[1] The purchase price is the lowest price that allows the firm to buy the number of shares sought in the offer, and the firm pays that price to all investors who tendered at or below that price.