FIN 302 Final Exam

Asset write ups

-In a taxable acquisition, assets of acquired firm can be revalued -If value of assets increases, tax deductions for depreciation will be a benefit, but this benefit will usually be more than offset by taxes due on the write-up

Procedures in a public issue of bonds

-Issue must be registered with the SEC -Prospectus is required -Registration statement for a public issue of bonds is different from the one for common stock, as the one for bonds must indicate an indenture

Quiet period

-all communications with the public must be limited to ordinary announcements and other purely factual matters -Quiet period ends 40 calendar days after an IPO

Strategic alliance

-an agreement between firms to cooperate in pursuit of a joint goal (i.e., target and starbucks)

Venture capital firms pool funds from

-individuals -pension funds -insurance companies -large corporations -university endowments

Liquidating dividends

-paid when some or all of the business has been liquidated (i.e., sold off)

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

Procedure of selling securities to the public

1. Management must obtain approval from board of directors 2. Firm must prepare a registration statement 3. SEC examines registration statement during a waiting period, during which time the firm may distribute copies of a preliminary prospectus 4. Firm cannot sell securities during waiting period, but oral fofers can be made 5. On effective date of registration statement, a price is determined with a full fledged selling effort gets underway

Why shareholders in bidder firms neither win nor lose very much on average

1.Anticipated merger gains may not be completely achieved, and shareholders experience losses 2.The bidding firms are usually much larger than the target firms 3.Management may not be acting in the interest of shareholders when it attempts to acquire other firms 4.Market for takeovers may be sufficiently competitive that the NPV of acquiring is zero because the prices paid in acquisitions fully reflect the value of the acquired firms 5.Announcement of a takeover may not convey much new information to the market about the bidding firm

Qualifications to use rule 415

1.Company must be rated investment grade; 2.Firm cannot have defaulted on its debt in the past three years; 3.Aggregate market value of firm's outstanding stock must be more than $150 million; and Firm must not have violated the Securities Act of 1934 in the past three years.

Costs of selling stock to the public

1.Except for straight debt offerings, there are substantial economies of scale 2.Costs associated with selling debt are substantially less than the costs of selling equity 3.IPOs have higher expenses than SEOs, but the difference is not as great as might originally be guessed 4.Straight bonds are cheaper to float than convertible bonds

Three basic types of underwriting involved in a cash offer

1.Firm commitment 2.Best efforts 3.Dutch auction

Underwriters services include:

1.Formulating the method used to issue the securities 2.Pricing the new securities 3.Selling the new securities

Sharing gains

1.If cash is used to finance an acquisition, selling firm's shareholders will not participate in potential gains from the merger

Factors involved in choosing between an acquisition stock and merger

1.In an acquisition by stock, no shareholder meetings must be held and no vote is required 2.In an acquisition by stock, the bidding firm can deal directly with the shareholders of the target firm by using a tender offer 3.Acquisition is occasionally unfriendly 4.Frequently, a significant minority of shareholders will hold out in a tender offer; target firm cannot be completely absorbed when this happens, and this may delay realization of merger benefits or be costly in some other way 5.Complete absorption of one firm by another requires a merger

Debt has what two distinguishing features

1.Interest paid on debt is tax deductible 2.Failure to meet debt obligations can result in bankruptcy

Stock prices tend to decline following the announcement of a new equity issue, although they tend to not change much following a debt announcement. Why?

1.Managerial information - Manager may feel the stock price is overvalued 2.Debt usage -They company may not be able to raise debt 3.Issue costs -Issuing new shares cost money 4.Dilution -Your shares now carry less power

Basic legal procedures one firm can use to acquire another firm

1.Merger or consolidation 2.Acquisition of stock 3.Acquisition of assets

Marketing gains might occur as a result of improvements in the following areas

1.Previously ineffective media programming and advertising efforts 2.A weak existing distribution network 3.An unbalanced product mix

M&M Proposition II shows that the firm's cost of equity can be broken down into two components:

1.RA is the required return on the firm's assets overall, and it depends on the nature of the firm's operating activities 2.(RA − RD) × (D/E) is determined by the firm's financial structure -for an all-equity firm, this component is zero

Basic types of dividends

1.Regular cash dividends 2.Extra dividends 3.Special dividends 4.Liquidating dividends

Why would firms rely on internal financing

1.Selling securities to raise cash can be expensive, so it makes sense to avoid doing so if possible 2.If managers believe their stock is undervalued, they do not want to issue equity because they don't want to sell it too cheaply

Potential explanations for reverse splits

1.Transaction costs to shareholders may be less 2.Liquidity and marketability of a company's stock might be improved 3.Stocks selling at prices below a certain level are not considered respectable 4.Stock exchanges have minimum price per share requirements; a reverse split may bring the stock price up to such a minimum 5.Companies sometimes perform reverse splits and, at the same time, buy out any stockholders who end up with less than a certain number of shares

Possible tax gains from an acquisition

1.Use of tax losses 2.Use of unused debt capacity 3.Use of surplus funds 4.Ability to write up the value of depreciable assets

Initial Coin Offering (ICO)

A company can raise funds by selling tokens, which often grant the holder the right to use the companies service in the future

Direct listing

A firm arranges for its stock to be listed on an exchange without marketing and other help from an underwriter

White knight

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

Dilution of proportionate ownership

A shareholder's reduction in proportionate ownership due to less-than-proportionate purchase of new shares

Acquisition control

Acquisition by paying cash does not affect control of acquiring firm, while acquisition with voting shares may have implications for control of merged firm

Takeovers occur through

Acquisitions, proxy contests, and going private transactions

Jumpstart Our Business Startups (JOBS) Act of 2012

Allows companies to raise money by selling equity through crowdfunding (originally allowed a company to issue up to 1 million of securities in a year, but later raised to maximum of $50).

Risk of a horizontal merger

Antitrust regulations

Countertender offer

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

Decision to pay dividend rests with the {}

Board of directors

Borrowing trade-off

Borrowing saves a firm money on its corporate taxes, but the more a firm borrows, the more likely it is that the firm will become bankrupt and have to pay the bankruptcy tax

Total systematic risk of the firm's equity has two parts: {} and {}

Business and financial risk

Venture capital initial investment stage

Called a seed or angel (includes concept, product development)

Venture capital early stage

Called series A or B (includes operational rollout, growth)

Consideration

Cash or securities offered to the target firm

M&M Proposition II

Changing the capital structure of the firm does not change the firm's total value, but it causes changes in the firm's debt and equity

Public offer

Company negotiates an agreement with investment banker to underwrite and distribute new shares

Gross spread

Difference between the underwriter's buying price and the offering price, representing compensation to underwriter

Venture capital is incredibly {}

Expensive - venture capitalists typically demand 40% or more of equity in the compony

Dividend yield

Expressed as percentage of market place

Public issue

Firm is registered to issue with the SEC

Target firm

Firm that is sought (and perhaps acquired)

Targeted repurchase

Firms may repurchase shares from specific individual stockholders

Crown jewel

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

Financial distress (static model)

Firms with a greater risk of experiencing financial distress will borrow less than firms with a lower risk of financial distress

Types of public issues

General cash offer, rights offer

Private issue

If the issue is to be sold to less than 35 investors, it can be done privately and a registration statement is NOT required

Implications of pecking order theory

No target capital structure Profitable firms use less debt Companies will want financial slack

Assumptions of M&M proposition I

No taxes or bankruptcy costs

Special dividends

Often one-time events that will not be repeated

Private equity

Often used to label the rapidly growing area of equity financing for nonpublic companies

Three types of share repurchases

Open market purchases, tender offer, targeted repurchase

Dividend payout

Percentage of net income or earnings per share

Crowdfunding

Practice of raising small amounts of capital from a large number of people (typically via the internet)

Venture capitalists frequently hold {}

Preferred stock

Growth equity

Private equity investment strategy that usually focuses on financing companies with proven business models, good customer bases, and positive cash flows and profits but that need additional capital to support their growth plans. (more common in the later stage)

Bookbuilding

Process of soliciting information about buyers and the prices and quantities they would demand

Methods of issuing new securities

Public (traditional negotiated cash offer), privileged subscription, nontraditional cash offer, private

When a company decides to issue a new security, it can sell it as a {} issue or {} issue

Public, private

Nontraditional cash offer

Qualifying companies can authorize all shared they expect to sell over a 2 year period and sell them when needed

A direct long-term loan avoids the cost of {}

Securities and Exchange Commission registration

Venture capital late stage

Series C, D etc... (includes expansion, eventually ends in exit)

Whether a firm should finance an acquisition with cash or with shares of stock depends on:

Sharing gains, taxes, control

Rule 415 allows

Shelf registration

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

Golden parachute

Some target firms provide compensation to top-level managers if a takeover occurs

{} speaks more to long-run financial goals or strategies, while {} is more concerned with the shorter-run, tactical issue of raising external funds to finance investments

Static theory, pecking-order theory

Taxes (static model)

Tax benefit from leverage is important only to firms that are in a tax-paying position -Firms that have substantial tax shields from other sources, such as depreciation, will get less benefit from leverage

Static model points out two relevant factors

Taxes, financial distress

Two basic forms of direct private long-term financing

Term loans and private placements

Priveleged Subscription

The company offers the new stock directly to its existing shareholders

Interest tax savings

The reduction in income tax resulting due to the tax deductibility of interest expense (tax savings)

Best efforts underwriting

The underwriter sells as much of the issue as possible, but can return any unsold shares to the issuer without financial responsibility -Has become uncommon in recent years

True or false: Dividend policy is irrelevant

True -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

Road show

Underwriter and company management will do presentations in multiple cities, pitching the stock

Angel investors

Usually individuals who invest their own money, but they tend to focus on smaller deals

Financial distress

When a firm is having significant problems in meeting its debt obligations

Seasoned equity offering

When an already public company needs to sell more shares it is called a seasoned equity offering (SEO)

Accounting dilution

When the market-to-book ratio is less than 1, increasing the number of shares does cause EPS to go down

Initial Public Offering (IPO)

a company's first equity issue made available to the public; also called an unseasoned new issue -All are cash offers

Poison pill

a financial device designed to make unfriendly takeover attempts unappealing, if not impossible

Syndicate

a group of underwriters formed to share the risk and to help sell an issue -One or more managers arrange, or co-manage, the offering

Prospectus

a legal document describing details of the issuing corporations the proposed offering to potential investors

Consolidation

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

Second equity offering

a new equity issue of securities by a company that has previously issued securities to the public

Distribution

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

Stock dividend

a payment made by a firm to its owners in the form of stock, diluting the value of each share outstanding

Dividend

a payment made out of a firm's earnings to its owners, in the form of either cash or stock

Rights offer

a public issue of securities in which securities are first offered to existing shareholders

Fair price provision

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

Registration statement

a statement filed with the SEC that discloses all material information concerning the corporation making a public offering

Reverse stock split

a stock split in which a firm's number of shares outstanding is reduced

Poison put

a variation on the poison pill described earlier

homemade dividend policy

ability of shareholders to undo the dividend policy of the firm and create an alternative dividend payment policy via reinvesting dividends or selling shares of stock

Tax free acquisition

acquisition is considered an exchange instead of a sale, so no capital gain or loss occurs at the time of transaction

Going-private transactions

all publicly owned stock in a firm is replaced with complete equity ownership by a private group (known as LBO)

Pecking order theory

alternative to the static theory -firms prefer to use internal financing first whenever possible, then issue debt, then issue equity

Horizontal acquisition

an acquisition of a firm in the same industry as the bidder

Proxy contest

an attempt to gain control of a firm by soliciting enough stockholder votes to replace existing management

Stock split

an increase in a firm's shares outstanding without any change in owners' equity -Expressed as a ratio instead of a percentage

General cash offer

an issue of securities offered for sale to the general public on a cash basis

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

Bear hug

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

Shark repellent

any tactic (a poison pill, for example) designed to discourage unwanted merger offers

Marketed claims

are the claims of stockholders and bondholders

Acquiring firm is referred to as the {}, the company that offers to distribute cash or securities to obtain the stock or assets of another company

bidder

Sale of low-dividend stocks involve {} and {} which are avoided by investment in high dividend securities

brokerage fees, other transaction costs

Regular cash dividends

cash payments made by a firm to its owners in the normal course of business, usually paid four times per year

Complementary resources

characterized by some firms acquiring others to make better use of existing resources or to provide the missing ingredient for success

Chewable pill

common in Canada but not in the U.S., is a pill that is installed by shareholder vote and can be redeemed by shareholder vote

Firms can offer securities to the highest bidding underwriter on a {} basis or negotiate directly with an underwriter on a {} basis

competitive offer, negotiated offer

Public utility holding companies are required to use {}

competitive underwriting

Corporate character

consists of the articles of incorporation and corporate bylaws that establish the governance rules of the firm

Standstill agreements

contracts wherein the bidding firm agrees to limit its holdings in the target firm (usually lead to the end of a takeover attempt)

Capital structure that maximizes value of the firm is also the one that minimizes the {}

cost of capital

Indirect bankruptcy costs

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

A firm becomes bankrupt when the value of its assets equals the value of its {}

debt

Term loans

direct business loans of typically one to five years

Direct bankruptcy costs

directly associated with bankruptcy, such as legal and administrative expenses -Because of the expenses associated with bankruptcy, bondholders won't get all that they are owed -Direct bankruptcy costs are a disincentive to debt financing

Stock prices react to unanticipated changes in {}

dividends

•When dividends are paid, the amount of the cash dividend is usually expressed in terms of {} (dividends per share)

dollars per share

Dividend growth lags {} growth

earnings

Dividend-paying companies tend to raise dividends only after {} have risen, and they don't increase or cut dividends in response to temporary earnings fluctuations

earnings

Financial risk

equity risk that comes from the financial policy (the capital structure of the firm)

Unused debt capacity

exists when firms do not use as much debt as they are able to, making them potential acquisition candidates

Deadhand pill

explicitly gives directors who installed the pill, or their handpicked successors, authority to remove the pill

Given the firm's business risk (and its cost of debt), financial risk is completely determined by {}

financial policy

Venture capital

financing for new, often high-risk ventures

Green shoe provision

gives the members of the underwriting group the option to purchase additional shares from the issuer at the offering price

Economies of vertical integration

have a main purpose of making it easier to coordinate closely related operating activities i.e., most forest product firms that cut timber also own sawmills and hauling equipment

Interest rates on term loans and private placements are usually {} than those on an equivalent public issue

higher

Three types of acquisitions

horizontal, vertical, conglomerate

Tax reform act of 1986 said

increase in value from writing up assets is now considered a taxable gain

Aggregate dividend and stock repurchases are massive, and they have {} steadily in nominal and real terms over the years

increased

Extra cash dividends

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

Underwriters

investment firms that act as intermediaries between a company selling securities and the investing public (Typically, the underwriter buys the securities for less than the offering price and accepts the risk of not being able to sell them)

Vertical acquisition

involves firms at different steps of the production process

Advantage of a merger

legally simple and does not cost as much as other forms of acquisition

Flotation costs associated with selling debt are much {} than the comparable costs associated with selling equity

less

Private placements

loans (usually long-term) provided directly by a limited number of investors

Dividends are heavily concentrated among a relatively small number of large, {} firms

mature

Surplus funds

may be spent by paying dividends, buying back its own shares, or acquiring shares in another firm

In the case of divestiture, a cah-strapped firm {}

may have to sell assets to raise capital (this commonly occurs in bankruptcy)

INCREASES IN MARKET POWER

may result in profit enhancements through higher prices and reduced competition for customers

cash financing is {} common than stock financing

more

Negotiated offer

more common approach, though there is evidence that competitive underwriting is cheaper to use

Disadvantage of a merger

must be approved by a vote of the stockholders of each firm •Typically, two-thirds (or more) of the share votes are required for approval

Open market purchases

occur when a firm purchases its own stock, just as anyone would buy shares of a particular stock, and the firm does not reveal itself as the buyer

Market value dilution

occurs when NPV of a project is negative, which causes the market price to drop

Comglomerate acquisition

occurs when the bidder and the target firm are in unrelated lines of business •Popular in the technology area

Strategic benefits

opportunities to take advantage of the competitive environment if certain things occur or, more generally, to enhance management flexibility with regard to the company's future operations

Greenmail

payments made to potential bidders to eliminate unfriendly takeover attempt

Tax exempt investors include

pension, endowment, and trust funds

M&M Proposition II states a firm's cost of equity capital is a {} of the firm's capital structure as investors demand higher return for more {}

positive linear function, risk

To determine offering price, the underwriter will meet with {}, typically large institutional buyers such as mutual funds

potential buyers

The costs of distributing bonds are lower in the {}

private market

More than 50% of all debt is issued {}

privately

Share rights plans

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

Capital gains effect

refers to fact that target firm's shareholders may have to pay capital gains taxes in a taxable acquisition

Financial leverage

refers to the extent to which a firm relies on debt

Takeover

refers to the transfer of control of a firm from one group of shareholders to another

Economies of scale

relate to the average cost per unit of producing goods and services

Purchase accounting method

requires that the assets of the target firm be reported at their fair market value on the books of the bidder

Direct placement is likely to have more {}

restrictive covenants

Write up effect

results from 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

Generally, stock prices {} when the current dividend is unexpectedly increased, and they {} when the dividend is unexpectedly decreased

rise, fall

Static theory of capital structure

says a firm borrows up to the point where tax benefit from extra dollar in debt equals cost that comes from increased probability of financial distress

Taxable acquisition

shareholders of target firm are considered to have sold their shares, and they will have capital gains or losses that will be taxed

Dividend growth will tend to be much {} than earnings growth

smoother

Lockup agreements

specify how long insiders must wait after an IPO before they can sell stock -Not required by law, but found in nearly all underwriting contracts -Have become fairly standardized in recent years at 180 days

M&M Proposition I

states the value of the firm is independent of the firm's capital structure -i.e., capital structure is irrelevant

Clientele effect

stocks attract particular groups based on dividend yield and the resulting tax effects

M&M Proposition II indicates that the cost of equity, RE, is given by a {} with a slope of (RA − RD)

straight line

Corporate investors receive {} on dividends if they own stock in another corporation

tax break

Net operating losses

tax losses a firm cannot use because they lost money on a pretax basis (and will not pay taxes)

Dividends received from the purchased firm are not {} in a merger

taxed

It is easier to renegotiate a {} or a {} in the event of a default

term loan, private placement

Static theory assumes {}

that the firm is fixed in terms of its assets and operations and it considers only possible changes in the debt-equity ratio.

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

Unlevered cost of capital

the cost of capital for a firm that has no debt, and it is represented by RU

Date of record

the date by which a holder must be on record to be designated to receive a dividend

Date of payment

the date on which dividend checks are mailed

Declaration date

the date on which the board of directors passes a resolution to pay a dividend

Ex-dividend date

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

Financial distress costs

the direct and indirect costs associated with going bankrupt or experiencing financial distress

Spin-off

the distribution of shares in a subsidiary to existing parent company stockholders (alternative to a carve-out)

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

Information content effect

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

Dutch auction underwriting

the offer price is set based on competitive bidding by investors; also called uniform price auction -Relatively new in IPO market, but very common in bond markets

Aftermarket

the period after a new issue is initially sold to the public

Synergy

the positive incremental net gain associated with the combination of two firms through a merger or acquisition

Stock repurchase (buyback)

the purchase, by a corporation, of its own shares of stock

Divestiture

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

Equity carve-out

the sale of stock in a wholly owned subsidiary via an IPO -particularly when the desired divestiture is a relatively large operating unit

Split-up

the splitting up of a company into two or more companies -company can elect to do or be forced to do so

Firm commitment underwriting

the underwriter buys the entire issue, assuming full financial responsibility for any unsold shares -Most prevalent type of underwriting in the U.S.

Joint venture

typically an agreement between firms to create a separate, co-owned entity established to pursue a joint goal

As debt-equity ratio rises, so too does the probability that the firm will be {} to pay its bondholders what was promised to them

unable

diversification reduces {} risk

unsystematic

Going private

what happens when the publicly owned stock in a firm is replaced with complete equity ownership by a private group, which may include elements of existing management

Assumptions of M&M proposition II

•No taxes but there is default risk

Shelf registration

•a company may register all issues it expects to sell within two years at one time, with subsequent sales permitted at any time within those two years -Both debt and equity securities can be shelf registered

Tender offer

•a public offer by one firm to directly buy the shares of another firm

Dilution

•the loss in existing shareholders' value in terms of ownership, market value, book value, or EPS