Midterm-exam for BMA's Principles of Corporate Finance for the Advanced Economics and Finance concentration on CBS
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| 3056967729 | What is the formula for ROE? | Nett. income/Equity | 0 | |
| 3056967730 | What is the formula for the EBITDA multiple? | Enterprise value/EBITDA | 1 | |
| 3056967731 | What is the formula for the EBIT multiple? | Enterprise value/EBIT | 2 | |
| 3056967732 | What is the formula for the P/E multiple? | equity value/Nett income or Share price/Earnings per share | 3 | |
| 3056967733 | What are the pros for using Multiples? | Fast and easy indexing of companies. Requires a minimum of calculations | 4 | |
| 3056967734 | What are the cons of using multiples? | Multiples are a VERY quick and dirty method for valuing a company. Furthermore, companies need to be VERY similar in order use Multiples | 5 | |
| 3056967735 | What is the formula for Gordon's Growth model? | d/(r-g) | 6 | |
| 3056967736 | What is the formula for CAPM and what is it often used for in Corporate Finance? | Re=Rf+B(Rm-Rf). Often CAPM is used to determine the required return on equity for a company. | 7 | |
| 3056967737 | What is the general formula for after-tax WACC? | WACC= Re*We + Rd*Wd*(1-Tc) | 8 | |
| 3056967738 | Are there other ways to determine WACC? | Indirectly WACC can be calculated using Gordons dividend growth Model. Alternatively, Arbitrage pricing theory as well as the Fama-French model can be used to determine the WACC. | 9 | |
| 3056967739 | What is the formula for a growing perpetuity? | Cashflow * 1/(r-g) | 10 | |
| 3056967740 | What is the formula for a t-period annuity? |  | 11 | |
| 3056967741 | What is the formula for a t-period growing annuity? |  | 12 | |
| 3056967742 | What does the pecking order theory state? | Cost of financing increases with assymetric information. Companies prioritize their sources of financing, first preferring internal financing, and then debt, lastly raising equity as a "last resort". Hence: internal financing is used first; when that is depleted, then debt is issued; and when it is no longer sensible to issue any more debt, equity is issued. | 13 | |
| 3056967743 | Why is equity considered last resort in pecking order theory? | Equity is a less preferred means to raise capital because when managers (who are assumed to know better about true condition of the firm than investors) issue new equity, investors believe that managers think that the firm is overvalued and managers are taking advantage of this over-valuation. As a result, investors will place a lower value to the new equity issuance. | 14 | |
| 3056967744 | What is adjusted present value - and what is the generalized formula? | APV=Base case NPV+PV impact The base case will be a "classic" 100% equity financed project. The PV impact could then be financing issues, such as a favourable loan in connection with the investment, or the opposite: having to finance the project with expensive debt. | 15 | |
| 3056967745 | What is a real option? | A real option is the option to postpone, change or abandon an investment creating additional value. | 16 | |
| 3056967746 | How can you calculate the value of a real option? | APV-NPV = Option value | 17 | |
| 3056967747 | What is the value drivers for real options? | * When there is high uncertainty about cash flows * When there is a lot of room for changes over time * When the decision can be postponed for a long time *When the firm is "alone" with potential to undertake the project (no threat of competition) | 18 | |
| 3056967748 | What is the cost for internal financing? | Re = cost of equity | 19 | |
| 3056967749 | What is the minimum required rate of return for internally financed projects? | WACC, but WACC is NOT the hurdle rate for all projects. Projects can easily be considered higher risk than the company's "core"-business and the hurdle rate should therefore be higher. | 20 | |
| 3056967750 | What is the payout ratio? | Dividends Per Share (DPS) / Earnings Per Share (EPS) | 21 | |
| 3056967751 | What is the dividend yield? | Dividends Per Share (DPS) / Stock price | 22 | |
| 3056967752 | What are Lintner's "Stylized Facts" on dividends? | 1. Firms have longer term target dividend payout ratios. 2. Managers focus more on dividend changes than on absolute levels. 3. Dividends changes follow shifts in long-run, sustainable levels of earnings rather than short-run changes in earnings. 4. Managers are reluctant to make dividend changes that might have to be reversed. 5. Firms repurchase stock when they have accumulated a large amount of unwanted cash or wish to change their capital structure by replacing equity with debt. | 23 | |
| 3056967753 | What is the argument for payout policies being irrelevant? | Investors can easily convert their shares to cash themselves. Dividends will therefore not have any impact on the value of the firm. (Consistent with Miller and Modigliani) | 24 | |
| 3056967754 | What are the 2 main arguments for payout policies decreasing value? | * The dividends paid out will no longer be available for financing new investments. Hence, it will be more expensive to finane investments. * Dividends are often taxed higher than capital gains from selling stocks | 25 | |
| 3056967755 | What are the 2 main arguments for payout policies increasing value? | * Clientele effects: Some investors will prefer dividend paying stocks and will therefore pay a premium for a dividend paying stock * Signaling: Only firm with decent earnings will pay out or even increase dividends * Agency problems: If you don't trust management to make proper investment decisions, you would rather want the earnings paid out than invested in negative NPV projects. | 26 | |
| 3056967756 | What is a stock split? | A stock split will change the amount of shares in a company by a given factor. Hence, a 1-2 split will double the amount of shares - hence halve the value of each share, but each shareholders value will remain the same | 27 | |
| 3056967757 | What is a stock dividend? | The company will distribute additional shares to the firm's stockholders. Overall the same as a stock split, however, the total share capital will increase with stock dividends, which it would not in the case of a stock split. | 28 | |
| 3056967758 | What are Modigliani & Miller's assumptions for their theorem? | * Companies can only have debt or equity * Financial markets are frictionless with no transaction costs * No corporate or private taxation * Firms cannot go bankrupt (or zero bankrupcy costs) * Everybody has the same information * Management serves shareholder interests 100% | 29 | |
| 3056967759 | What is MM proposition I? | Based on the assumptions the value of a levered company will be equal to an unlevered company | 30 | |
| 3056967760 | What is MM proposition II? | The WACC will remain constant regardless of capital structure. | 31 | |
| 3056967761 | What are the main benefits of debt? | * Tax shield * Possible incentives for management to run faster. Good for companies without a strong main shareholder, where management is relatively stronger than shareholders * Possible signalling effects | 32 | |
| 3056967762 | What are the main costs of debt? | Increased bankruptcy costs Conflict between creditors and shareholders Loss of flexibility - cannot invest freely | 33 | |
| 3056967763 | What happens to the tax shield if personal taxes are taken into account? | The value of debt (the tax shield) will fall. | 34 | |
| 3056967764 | What are the costs of financial distress? | * Direct costs Lawyers' fees, Fire sales of assets, Administrative costs Shareholders' efforts to receive a liquidation dividend * Indirect costs Order cancellations, Less trade credit, Reduced productivity No more access to financing, Incalculable human costs - employees leaving, Risk shifting - stockholders may want to take high risky projects rather than projects with positive NPV | 35 | |
| 3056967765 | What is the investment decision rule for IRR? | Invest in any project with IRR above opportunity cost of capital. | 36 | |
| 3056967766 | How is the profitability index of an investment calculated? | NPV/initial investment | 37 | |
| 3056967767 | What is a preferred stock? | A stock with "guaranteed" dividends (paid before commen stock). However, often no voting rights. | 38 | |
| 3056967768 | How is EPS calculated? | Earnings/Number of shares, where earnings can be defined in different ways. Typically, Net Income is used. | 39 | |
| 3056967769 | What is enterprise value? | Equity value + debt value | 40 | |
| 3056967770 | How do you calculate equity value using DCF? | First value enterprise value with DCF and thereafter deduct the net debt. | 41 | |
| 3056967771 | What is the plowback ratio? | 1-payout ratio. The part of earnings retained by the company. | 42 | |
| 3056967772 | Which multiples are used to value the full company (enterprise value)? | EBIT and EBITDA multiples | 43 | |
| 3056967773 | Which multiples are used to value the equity alone? | P/E multiple as well as P/BV | 44 | |
| 3056967774 | What are the pro's of IRR? | Even if you don't know the discount rate, you an still find IRR. Easy to communicate/understand. | 45 | |
| 3056967775 | What are the con's of IRR? | Same string of cashflows can have different IRRs. Especially a problem if you have negative cashflows. | 46 | |
| 3056967776 | What are incremental cashflows? | Include All Indirect Effects Forget Sunk Costs Include Opportunity Costs Recognize the Investment in Working Capital Beware of Allocated Overhead Costs | 47 | |
| 3056967777 | How is the free cash flow obtained? | Total Cash Flow = + Cash Flow from Operations - Inv. in fixed assets - Inv. in working capital | 48 | |
| 3056967778 | How do you calculate cash flow from operations? | Adjusted Accounting Profits - I: 1. Cash flow from operations= EBITDA - EBIT x Tc 2. Adjusted Accounting Profits - II: Cash flow from operations= profit after tax + depreciation 3. Dollars In Minus Dollars Out: Cash flow from operations= revenues - cash expenses - taxes | 49 | |
| 3056967779 | Which issues should you mind, when estimating Beta for a stock? | * Beta can vary greatly over time * A time period of 3-5 years is normally recommended (CFA) * The results can change depending on the frequency of the data, as well as the index which is used as "market" * If a stock is not liquid, we could face issues with the frequency of the data | 50 | |
| 3056967780 | How should you estimate WACC (in practice)? | *Weights: Calculate both basis market values and target capital structure *Cost of equity: Use both CAPM and Dividend growth model *Compare to close competitors - WACC is different for different projects even in the same company! Dogfood vs. nuclear example. | 51 | |
| 3056967781 | Which problems can principal-agent issues lead to? | Reduced effort, high salaries, empire building, avoiding risk | 52 | |
| 3056967782 | What is a free rider problem? | A free rider problem arises when the equity is divided in too many small bits, without a main shareholder to "control" management. Thereby the small investers rely on others to monitor the company. This can be partly solved by leveraging the company with short term debt, prompting results to repay debt. | 53 | |
| 3056967783 | In connection with dividends, what happens to the stock price, and when? | The stock price will drop relative to the dividend paid out. It will drop after the ex-div date (normally a week prior the paydate) | 54 | |
| 3056967784 | Why does many shareholders prefer companies NOT to hedge risks? | * Investors can easily diversify their portfolios themselves * If investors wanted a 1:1 hedge, they could do it themselves * Hedging is costly in many cases | 55 | |
| 3056967785 | In relation to capital structure, why can it make sense to hedge? | It decreases the probability (thereby indirectly the cost) of bankruptcy. A hedged position will not count as a risky investment and will to a lesser degree draw on the debt capacity | 56 | |
| 3056967786 | In relation to pricipal-agency issues, why does it makes sense to hedge? | To avoid managers blaming "the market", "bad luck" or "a low oil price" | 57 | |
| 3056967787 | From management's point of view, why does it make sense to hedge? | Removes risk from non-core activities (like Forex, debt etc.) and instead let's the management focus on taking risk in the core-business | 58 | |
| 3056967788 | How should you hedge your position with options if you PRODUCE oil? | Buy a put option. | 59 | |
| 3056967789 | How should you hedge your position with futures if you PRODUCE oil? | Sell a forward/future | 60 | |
| 3056967790 | What does value at risk meassure? | The worst possible loss, for a given time horizon at a given probability. | 61 | |
| 3056967791 | What would a VAR of $5000, t= 1 month, P=95% mean? | That with 95% certainty the maximum loss for a 1 month period would be 5000 | 62 | |
| 3056967792 | How do you treat cash when calculating enterprise value and why? | EV= Vd+Ve-Cash Cash is not expected to generate any further profits. Hence, it should be deducted. | 63 |
