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47 Cards in this Set
- Front
- Back
NPV |
Initial Cash Outlay - Discounted future cash inflows |
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IRR |
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 |
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Initial Outlay |
Initial Outlay = FCInv + WCInv Fixed capital investments (equipment) plus working capital |
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Operating Cash Flow |
= 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. |
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Terminal Non Operating Cash Flow |
TNOCF= SALt + NWCinv - T(SALt - Bt) SALt= pretax cash proceeds from sale of fixed capital. Bt = book value of the fixed capital sold. |
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Capital Budgeting for Replacement |
Same as expansion but reduce initial cash outlay by the salvage value of the equipment being replaced |
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Multiple projects with different lives |
Least common life method (reinvest the shorter project at same rate and cash flow for another period...cash outlay)
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Equivalent Annual Annuity Method |
Calculate NPV and convert to an annuity. Compare payments: NPV=-PV |
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Addressing Inflation |
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 |
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Capital Rationing |
Choose the combination of projects with highest NPV |
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Real Options |
?
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Economic Income |
Economic Income = Accounting Income + Change In Projects MV |
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Difference in depreciation |
Economic Depr. - Based on change in MV Account Depr. - Based on initial outlay Interest expense deducted before calculating accounting income |
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Economic Profit |
Economic Profit = NOPAT - $WACC NOPAT = Net operating profit after taxes = net income (1-tax rate) $WACC = WACC x (shareholders equity + long term debt) |
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Residual Income |
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 |
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Claims valuation method |
Take proportionate cash flows based on proportion of debt to equity and discount using appropriate rate (interest rate or cost of equity) |
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MM Prop 1 (No Taxes) |
Capital Structure irrelevant (no taxes, bankruptcy, transaction costs) |
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MM Prop II (No taxes) |
Increased used of cheaper debt makes equity more expensive. No change to WACC |
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MM Prop I (With Taxes) |
Tax shields adds value, value maximized at 100% debt |
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MM Prop II (With Taxes) |
Tax shields adds value, WACC minimized at 100% debt |
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Investor Preferences toward dividend policy |
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 |
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Double Taxation or split rate system |
effective tax rate = corporate tax rate + (1-corp. rate)(individual tax rate) |
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Imputation System |
effective tax rate is the shareholder's individual tax rate |
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Signals of dividend changes |
Initiation - Ambiguous Increase - Positive Signals Decrease - Negative signal unless money is being used to for profitable investments |
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Price change of stock post ex-dividend |
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Target Payout Ratio Adjustment Model |
? |
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Dividend Coverage Ratio |
Dividend Coverage Ratio = Net income / dividends |
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Free Cash Flow to Equity Coverage Ratio |
FCFE Coverage Ratio = FCFE / (dividends + share repurchase) |
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Share Repurchases |
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 |
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Dividend Policy Approaches |
Residual dividends Longer term residual dividend Dividend stability Target payout ratio |
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Residual Dividends |
Earnings less funds retained to finance capital budget |
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Longer term residual dividend |
Forecast capital budget, smooth dividend payout |
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Target payout ratio |
Long-term payout ratio |
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Shareholder impact analysis |
Forces firm to identify the most critical groups |
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Ethical Decisions |
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 |
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Corporate Governance |
Mitigate Conflicts of interest between managers and share holders. And Directors and Shareholders Ensure assets are used to benefit shareholders |
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Merger Types |
Horizontal, vertical, conglomerate |
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Merger Motivations |
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 |
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Pre-Offer Defense Mechanisms |
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 |
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Post-Offer Defense Mechanisms |
Litigation, greenmail, share repurchase, leveraged recapitalization, the crown jewel, the pac man, and just say no and white knight with white square |
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Herfindahl Hirschman Index (HHI) |
Higher HHI means more likely regulators will block mergers. Higher HHI means greater current market concentration
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Methods to Determine Target Value |
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))) |
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Comparables |
Use comparable companies' valuations + takeover premium |
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Comparable transaction analysis |
Target value from takeover transactions; takeover premium included |
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Merger Valuations |
Combined Firm: Value Combined = Value A + Value B + S - C Takeover Premium: Gain = TP = P - V Synergies: Gain = S - TP = S - (P - V) |
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Merger Risk and Reward |
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 |
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Divestiture |
Equity carve out, spin-off, split-off, and liquidations |