FIN 302 Final Exam

Pros of Paying Dividends

1) Cash dividends underscore good results and provide support to stock price 2) Dividends may attract institutional investors 3) Stock price usually increases with a new or increased dividend 4) Dividends absorb excess cash and may reduce agency costs

Cons of Paying Dividends

1) Dividends are taxed to recipients 2) Dividends can reduce internal sources of funding *May force firm to forgo positive NPV projects *May require external financing 3) Once established, dividends cuts are hard to make without adversely affecting a firm's stock price

Cash Budget

A budget that estimates cash inflows and outflows during a particular period like a month or a quarter

Conglomerate Acquisition

A combination of two companies involved in unrelated lines of business

Diversification

A commonly mentioned as a benefit of a merger, but diversification per se probably does not create value

Stock Repurchase

A company's repurchasing, or buying back, of its own common stock

Spin-Off

A corporation creates a spinoff by distributing 100% of its ownership interest in that business unit as a stock dividend to existing shareholders.

Line of Credit

A financial arrangement between a firm and a bank in which the bank pre-approves credit up to a specified limit, provided that the firm maintains an acceptable credit rating

White Knight

A firm facing an unfriendly merger offer might arrange to be acquired by a different, friendly firm. •The firm is thereby rescued by a "white knight"

Strategic Alliance

A long-term partnership between two or more companies established to help each company build competitive market advantages

Consolidation

A merger in which an entirely new firm is created and both the acquired firm and the acquiring firm cease to exist

Acquisition of Assets

A merger or consolidation in which an acquirer purchases the selling firm's assets.

Greenmail

A payment by a firm to a hostile party for the firm's stock at a premium, made when the firm's management feels that the hostile party is about to make a tender offer

Distribution

A payment made by a firm to its owners from sources other than current or accumulated retained earnings

Stock Dividend

A pro rata (proportional to ownership) distribution of the corporation's own stock to stockholders

Letter of Credit

A promise by the bank to pay the seller a given amount if certain conditions are met

A restrictive short-term financial policy:

A restrictive short-term financial policy means a high proportion of short-term debt relative to long-term financing

Inventory loan

A secured short-term loan to purchase inventory and comes in one of three forms:

Joint Venture

An agreement between two or more companies to share a business project

Noncommitted Line of Credit

An informal agreement that permits a company to borrow up to a prearranged limit without having to follow formal loan procedures and paperwork

Tender Offer

An offer to purchase the stock of a firm targeted for acquisition at a price just high enough to tempt stockholders to sell their shares

Lockup

An option granted to a friendly suitor (a white knight, perhaps) giving it the right to purchase stock or some of the assets (the crown jewels, possibly) of a target firm at a fixed price in the event of an unfriendly takeover

Countertender Offer

Better known as the "Pac-Man" defense, the target responds to an unfriendly overture by offering to buy the bidder

Payout

Cash dividends and the value of shares repurchased in any given year.

Credit Card Receivable Funding

Company goes to a factor and receives cash up front, after which a portion of each credit card sale (perhaps 6 to 8%) is routed directly to the factor by the credit card processor until the loan is paid off

Commerical Paper (CP)

Consists of short-term notes issued by large, highly rated firms

Safety Reserve Costs

Costs of lost sales, lost customer goodwill, and disruption of production schedules

Shortage Costs

Costs resulting when demand exceeds the supply of inventory; often unrealized profit per unit

Trade Credit

Credit involves a firm increasing the accounts payable period (i.e., the firm may take longer to pay its bills)

Date of Record

Date directors specify for identifying stockholders to receive dividends

Date of Payment

Date the corporation makes the dividend payment.

Shark Repellent

Defenses against takeover attempts

EPS vs EBIT

EPS is twice as sensitive to changes in EBIT because of the financial leverage employed

Crown Jewel

Firms often sell or threaten to sell major assets—crown jewels—when faced with a takeover threat (i.e., scorched earth strategy)

Commited Line of Credit

Formal legal arrangements that usually involve a commitment fee paid by the firm to the bank

Homemade Dividends

Idea that individual investors can undo corporate dividend policy by reinvesting dividends or selling shares of stock

A flexible short-term financial policy:

Increases a firm's need for long-term financing.

Unlevering the Stock

Involves reverting a given amount the leverage back to its given capital structure. This can be accomplished by an individual through lending money

negative shareholders' equity

Negative shareholders' equity is a red flag for investors because it means a company's liabilities exceed its assets

Current Liabilities

Obligations that a company expects to pay within the next year or operating cycle, whichever is longer

Purchase Order Financing

Obtaining cash from a lender who, for a fee, advances the amount of the borrower's cost of goods sold for a specific customer order

Reverse Stock Split

Occurs when a corporation calls in its stock and replaces each share with less than one new share; increases both market value per share and any par or stated value per share

Financial Slack

Provide enough additional financial resources so that profitable projects would not be foregone.

Share Rights Plan

Provisions allowing existing stockholders to purchase stock at some fixed price should an outside takeover bid come up, discouraging hostile takeover attempts

The Purchase Method

Record assets and liabilities acquired in a merge or acquisition at their fair value on the transaction date

Restructuring

Redesigning an organization so that it can more effectively and efficiently serve its customers

Financial Leverage

Refers to the extent to which a firm relies on debt

Dual Class Capitalization

Some firms have more than one class of common stock and that voting power is typically concentrated in a class of stock not held by the public

Synergy

Successful merger requires value of the whole (i.e., combined firm) exceed the sum of the parts (i.e., values of separate firms)

Proxy Contest

Takeover attempt in which outsiders compete with management for shareholders' votes

Dividend Policy

The amount of dividends management decides to pay out to shareholders.

How should a firm go about choosing its debt-equity ratio?

The capital structure that maximizes the value of the firm is the one financial managers should choose for the shareholders

Merger

The complete absorption of one company by another, wherein the acquiring firm retains its identity and the acquired firm ceases to exist as a separate entity

Direct Bankruptcy Costs

The costs that are directly associated with bankruptcy, such as legal and administrative expenses

Financial Risk

The equity risk that comes from the financial policy (the capital structure of the firm) •Given the firm's business risk (and its cost of debt), financial risk is completely determined by financial policy

Business Risk

The equity risk that comes from the nature of the firm's operating activities •Depends on firm's assets and operations; unaffected by capital structure •The greater a firm's business risk, the greater RA will be, and all other things equal, the greater will be the firm's cost of equity

Net Cash Inflow

The excess of total cash inflows over total cash outflows

Order Cost

The expenses incurred in placing and receiving orders from suppliers

Write-Up Effect

The fact that, in a taxable acquisition, the assets of the selling firm are revalued or "written up" from their historic book value to their estimated current market value

Maturity Factoring

The factor forwards the money on an agreed-upon future date

Under Assignment

The lender has the receivables as security, but the borrower is still responsible if a receivable can't be collected

Information Content Effect

The market's reaction to a change in corporate dividend payout

The interest tax shield is a key reason why: -The net cost of debt is generally less than the cost of equity. -Companies prefer equity financing over debt financing. -The value of an unlevered company is equal to the value of a levered company. -The cost of debt is equal to the cost of equity for a levered company. -The required rate of return on assets rises when debt is added to the capital structure.

The net cost of debt is generally less than the cost of equity

Clientelle Effect

The notion that investors will invest in the stock of firms with dividend policies that reflect a desired dividend payout structure

Dividend

The portion of corporate profits paid out to stockholders

Dividend Smoothing

The practice of maintaining relatively constant dividends

Going Private

The process by which all publicly owned shares of common stock are repurchased or retired, thereby eliminating listing fees, annual reports, and other expenses involved with publicly owned companies.

Conventional Factoring

The receivable is discounted and sold to the lender (the factor); once it is sold, collection is the factor's problem, and factor assumes the full risk of default on bad accounts

Divestiture

The sale of assets, operations, divisions, and/or segments of a business to a third party

Operating Cycle

The time span during which cash is paid for goods and services, which are then sold to customers from whom the business collects cash.

Takeover

The transfer of control of a firm from one group of shareholders to another

Acquisition of Stock

To purchase the firm's voting stock with an exchange of cash, shares of stock, or other securities

WACC

Weighted average cost of capital. The average cost of financing a firm in percentage terms.

Vertical Acquisition

a firm acquiring a supplier or distributor of one or more of its goods or services

Golden Parachute

a prearranged contract with managers specifying that, in the event of a hostile takeover, the target firm's managers will be paid a significant severance package

Cash Dividend

a pro rata (proportional to ownership) distribution of cash to stockholders

Fair Price Provision

a requirement that all selling shareholders receive the same price from a bidder

Revolving Line of Credit

a type of open account credit offered by banks and other financial institutions that can be accessed by writing checks against demand deposit or specially designated credit line accounts

Leveraged Buyout (LBO)

an attempt by employees, management, or a group of investors to purchase an organization primarily through borrowing

Bear Hug

an unfriendly takeover offer designed to be so attractive that the target firm's management has little choice but to accept it

Current Assets

cash and other assets expected to be exchanged for cash or consumed within a year

Optimal Capital Structure

combination of debt and equity financing that minimizes the average cost of capital

Inventory Turnover Ratio

cost of goods sold/average inventory

Carrying Costs

costs that rise with increases in the level of investment in current assets

Dividend Restrictions

debt contracts might limit the percentage of income that can be paid out as dividends

Poison Put

forces the firm to buy securities back at some set price

Capital Gains Effect

if taxable, the target's shareholders may end up paying capital gains taxes, driving up the cost of the acquisition

Extra Cash Dividend

indication that the "extra" amount may not be repeated in the future

Free Cash Flow

net cash provided by operating activities after adjusting for capital expenditures and cash dividends paid

Horizontal Aquisition

one firm buys another in the same industry

Tax-Exempt Investors

pension, endowment, and trust funds

indirect bankruptcy costs

the costs of avoiding a bankruptcy filing incurred by a financially distressed firm

Declaration Date

the date on which the board of directors officially approves a dividend

Ex-Dividend Date

the date one business days before the date of record, establishing those individuals entitled to a dividend

Stock Split

the division of a single share of stock into more than one share

Cost of Equity Capital

the opportunity cost of the equity invested in the business; investors required rate of return

Compensating Balance

the portion of an unsecured loan that is kept on deposit at a lending institution to protect the lender and increase the lender's return

M&M Proposition II

the proposition that a firm's cost of equity capital is a positive linear function of the firm's capital structure

M&M Proposition I

the proposition that the value of the firm is independent of the firm's capital structure

Interest Tax Shield

the tax saving attained by a firm from interest expense

Static Theory of Capital Structure

the theory that a firm borrows up to the point where the tax benefit from an extra dollar in debt is exactly equal to the cost that comes from the increased probability of financial distress

Cash Cycle

the time between cash disbursement and cash collection

Inventory Period

the time it takes to acquire and sell inventory

Flotation Costs

the transaction cost incurred when a firm raises funds by issuing a particular type of security

Homemade Leverage

the use of personal borrowing to change the overall amount of financial leverage to which the individual is exposed

Goodwill

the value of all favorable attributes that relate to a company that are not attributable to any other specific asset

Going Private Transactions

transactions in which all publicly owned stock in a firm is replaced with complete equity ownership by a private group

Financial Distress

when a firm has difficulty meeting its debt obligations

Tax Reform Act of 1986

write-up effect was sharply curtailed

True or false: Dividends are Irrelevant

•False •Investors prefer higher dividends to lower dividends at any single date if the dividend level is held constant at every other date

Standstill Agreement (Defense Strategy)

•In a targeted repurchase, a firm buys a certain amount of its own stock from an individual investor, usually at a substantial premium •These payments made to potential bidders to eliminate unfriendly takeover attempts are referred to as greenmail

marketed claims vs. non marketed claims

•In the extended pie model, there is an important distinction between claims such as those of stockholders and bondholders (i.e., marketed claims) versus those of the government and potential litigants in lawsuits (i.e., nonmarketed claims) •Marketed claims can be bought and sold in financial markets, but nonmarketed claims cannot

True or false: Dividend policy is Irrelevant

•True, at least in the simple case •Dividend policy by itself cannot raise the dividend at one date while keeping it the same at all other dates; rather, dividend policy merely establishes the trade-off between dividends at one date and dividends at another date

Poison Pills

•Upon an unfriendly takeover attempt, holders of rights can buy stock in the target firm at half price and, simultaneously, rights owned by the raider (the acquirer) are voided •Goal of flip-in provision is to massively dilute the raider's ownership position, thereby greatly increases cost of merger to the bidder