Cfa Level 2 - Corporate Finance

Front 1

NPV

Back 1

Initial Cash Outlay - Discounted future cash inflows

Front 2

IRR

Back 2

Internal Rate of Return is the rate required to discount cash flows to a present value of zero. Higher IRR is a more valuable product because the cash flows are high and quick

Front 3

Initial Outlay

Back 3

Initial Outlay = FCInv + WCInv

Fixed capital investments (equipment) plus working capital

Front 4

Operating Cash Flow

Back 4

= incremental cash inflows over the capital assets economic life. OCF = (S-C-D)(1-T) +D = (S-C)(1-T) + (TD) Where: S=sales, C=cash operating costs, D=depreciation and T = tax.

Front 5

Terminal Non Operating Cash Flow

Back 5

TNOCF= SALt + NWCinv - T(SALt - Bt)

SALt= pretax cash proceeds from sale of fixed capital. Bt = book value of the fixed capital sold.

Front 6

Capital Budgeting for Replacement

Back 6

Same as expansion but reduce initial cash outlay by the salvage value of the equipment being replaced

Front 7

Multiple projects with different lives

Back 7

Least common life method (reinvest the shorter project at same rate and cash flow for another period...cash outlay)

Front 8

Equivalent Annual Annuity Method

Back 8

Calculate NPV and convert to an annuity. Compare payments:

NPV=-PV

Front 9

Addressing Inflation

Back 9

Discount nominal cash flows (multiply cash flows by inflation rate raised to time) by nominal discount rate

Discount real cash flows (actual cash flows) by real rate, nominal discount - inflation rate

Front 10

Capital Rationing

Back 10

Choose the combination of projects with highest NPV

Front 11

Real Options

Back 11

?

Front 12

Economic Income

Back 12

Economic Income =

Accounting Income + Change In Projects MV

Front 13

Difference in depreciation

Back 13

Economic Depr. - Based on change in MV

Account Depr. - Based on initial outlay

Interest expense deducted before calculating accounting income

Front 14

Economic Profit

Back 14

Economic Profit = NOPAT - $WACC

NOPAT = Net operating profit after taxes

= net income (1-tax rate)

$WACC = WACC x (shareholders equity + long term debt)

Front 15

Residual Income

Back 15

RI = Net Income - Equity Charge

Equity Charge = Equity Capital x Cost of Equity

Vt = BVo + RI/(1-r) + RI/(1-r)2

r = cost of equity

Front 16

Claims valuation method

Back 16

Take proportionate cash flows based on proportion of debt to equity and discount using appropriate rate (interest rate or cost of equity)

Front 17

MM Prop 1 (No Taxes)

Back 17

Capital Structure irrelevant (no taxes, bankruptcy, transaction costs)

Front 18

MM Prop II (No taxes)

Back 18

Increased used of cheaper debt makes equity more expensive. No change to WACC

Front 19

MM Prop I (With Taxes)

Back 19

Tax shields adds value, value maximized at 100% debt

Front 20

MM Prop II (With Taxes)

Back 20

Tax shields adds value, WACC minimized at 100% debt

Front 21

Investor Preferences toward dividend policy

Back 21

Tax free world, dividend policy doesn't matter because synthetic dividends can be created

But investors prefer certain immediate cash over capital gains

Except for tax aversion of dividends

Front 22

Double Taxation or split rate system

Back 22

effective tax rate =

corporate tax rate +

(1-corp. rate)(individual tax rate)

Front 23

Imputation System

Back 23

effective tax rate is the shareholder's individual tax rate

Front 24

Signals of dividend changes

Back 24

Initiation - Ambiguous

Increase - Positive Signals

Decrease - Negative signal unless money is being used to for profitable investments

Front 25

Price change of stock post ex-dividend

Back 25

Front 26

Target Payout Ratio Adjustment Model

Back 26

?

Front 27

Dividend Coverage Ratio

Back 27

Dividend Coverage Ratio

= Net income / dividends

Front 28

Free Cash Flow to Equity Coverage Ratio

Back 28

FCFE Coverage Ratio

= FCFE / (dividends + share repurchase)

Front 29

Share Repurchases

Back 29

Share repurchase is equivalent to cash dividend with equal tax treatment

Why?

1) Potential Tax Advantage

2) Share price falling and signaling

3) Added flexibility

4) Offsetting dilution from employee stock options

5) Increasing financial leverage

Front 30

Dividend Policy Approaches

Back 30

Residual dividends

Longer term residual dividend

Dividend stability

Target payout ratio

Front 31

Residual Dividends

Back 31

Earnings less funds retained to finance capital budget

Front 32

Longer term residual dividend

Back 32

Forecast capital budget, smooth dividend payout

Front 33

Target payout ratio

Back 33

Long-term payout ratio

Front 34

Shareholder impact analysis

Back 34

Forces firm to identify the most critical groups

Front 35

Ethical Decisions

Back 35

Friedman Doctrine - Do what's legal and increase profits

Utilitarianism - Highest good for most people

Kantian Economics - People are more than just an economic input

Rights Theory - Just because it's legal doesn't mean it's right

Justice Theory - Veil of ignorance

Front 36

Corporate Governance

Back 36

Mitigate Conflicts of interest between managers and share holders. And Directors and Shareholders

Ensure assets are used to benefit shareholders

Front 37

Merger Types

Back 37

Horizontal, vertical, conglomerate

Front 38

Merger Motivations

Back 38

Achieve synergies, more rapid growth, increased market power, gain access to unique capabilities, diversify, tax benefits, unlock hidden value, achieving international goals, and bootstrapping earnings

Front 39

Pre-Offer Defense Mechanisms

Back 39

Poison pills and puts, reincorporate in a state w/ restrictive takeover laws, staggered board directors, restricted voting rights, supermajority voting, fair price amendment, golden parachutes

Front 40

Post-Offer Defense Mechanisms

Back 40

Litigation, greenmail, share repurchase, leveraged recapitalization, the crown jewel, the pac man, and just say no and white knight with white square

Front 41

Herfindahl Hirschman Index (HHI)

Back 41

Higher HHI means more likely regulators will block mergers. Higher HHI means greater current market concentration

Front 42

Methods to Determine Target Value

Back 42

DCF method - Target proforma FCF discounted at adjusted WACC

Adjust WACC by unlevering beta, adjust based on investment risk, lever back

Unlevered Beta = Levered Beta / (1 + ((1 – Tax Rate) x (Debt/Equity)))

Levered Beta = Unlevered Beta x (1 + ((1 – Tax Rate) x (Debt/Equity)))

Front 43

Comparables

Back 43

Use comparable companies' valuations + takeover premium

Front 44

Comparable transaction analysis

Back 44

Target value from takeover transactions; takeover premium included

Front 45

Merger Valuations

Back 45

Combined Firm:

Value Combined = Value A + Value B + S - C

Takeover Premium:

Gain = TP = P - V

Synergies:

Gain = S - TP = S - (P - V)

Front 46

Merger Risk and Reward

Back 46

Cash offer: Acquirer assumes risk and receives rewards

Stock offer: Some of risk and reward is shifted to target.

Cash is better for acquirer if synergies are present, stock for target

Front 47

Divestiture

Back 47

Equity carve out, spin-off, split-off, and liquidations