Corporate Finance Examination

Corporate Finance Risk-free rate - Answer- No such thing...but many use 10 year Treasury bonds as a proxy for the risk-free rate Flotation Costs - Answer- the transaction cost incurred when a firm raises funds by issuing a particular type of security Flotation Cost Adjustment - Answer- the amount that must be added to cost of retained earnings to account for flotation costs to find cost of new common stock pure play method - Answer- a method for estimating a project's or division's beta that attempts to identify publicly traded firms engaged solely in the same business as the project or division Accounting Beta Method for Estimating Beta - Answer- Run regression between project's ROA and S&P Index ROA. Accounting betas are correlated (0.5 - 0.6) with market betas. But normally can't get data on new projects' ROAs before the capital budgeting decision has been made. effective rate of interest - Answer- the annual rate of return that is actually earned (or charged) during the period the funds are held (or borrowed) k=compounding periods Special Purpose Vehicle - Answer- A legal entity to which the assets used as collateral in an ABS issue are sold. This transaction separates the assets backing the ABS from the other assets of the company that creates the SPV. horizontal merger - Answer- the combination of two or more firms competing in the same market with the same good or service vertical merger - Answer- the combination of two or more firms involved in different stages of producing the same good or service conglomerate merger - Answer- the joining of firms in completely unrelated industries congeneric merger - Answer- A merger of firms in the same general industry, but for which no customer or supplier relationship exists. hostile takeover - Answer- the acquisition of a company over the opposition of its management friendly takeover - Answer- An acquisition in which the management of the acquired company welcomes the firm's buyout by another company. The Williams Act - Answer- is 1) designed to regulate the conduct of those attempting to take over a company & 2) force acquiring firms to disclose more info about their offers Free Cash Flow to Equity - Answer- Cash flow that would be available for distribution to common shareholders; = Cash Flow from Operations (FCF) - Interest Expense _ Interest tax shield + Debt Issued - Debt Repaid pure financial merger - Answer- No operating synergies are expected, so incremental post-merger cash flows are just target firm's expected cash flows operating merger - Answer- A merger in which the operations of the firms involved are integrated in hope of achieving synergistic benefits. Value of a firm's operations - Answer- Present value of a firm's expected FCF's discounted at its WACC Business Risk - Answer- The possibility of loss (failure) or gain (success) inherent in conducting business if the firm has no leverage Operating Leverage - Answer- a measure of how sensitive net operating income is to a given percentage change in dollar sales (Extent to which fixed costs are used in a firm's operations) financial risk - Answer- Additional risk placed on the common stockholders as a result of the decision to finance with debt Leveraged Buyout (LBO) - Answer- a purchase in which a group of investors borrows money from banks and other institutions to acquire a company (or a division of one), using the assets of the purchased company to guarantee repayment of the loan Market Timing Theory - Answer- Managers try to "time the market" when issuing securities; issue debt for upward sloping term structure and LT debt when term structure is flat signaling theory - Answer- The announcement of a stock offering is generally taken as a signal that the firm's prospects as seen by its own management are not good; conversely, a debt offering is taken as a positive signal. Importance of tax in capital structure - Answer- Managers should explicitly consider tax benefits when making capital structure decisions. Tax benefits obviously are more valuable for firms with high tax rates. Firms