finance exam

examples of valuation

EV/EBITDA - price to sales - price to earnings - P/E NTM

if a company issued $50 worth of new shares at the current share price of $0.50 per share, what would be the new share price?

$0.50 --> it wouldn't change

A company's share price is $0.80/share with 100 shares. If they pay out $25 of dividends, what would be its new share price?

$0.55/share

What will be the cash balance if $20 of debt is issued to help finance a $40 dividend? OG cash balance = $50

$30

Why could acquisitions fail?

- Overpayment for the acquired company - synergies not realized - cultural clashes

possible consequences of the usual compensation model/ industrial structure for equity analysts

- analysts will work hard to provide accurate valuations for companies - high-ranking analysts may "herd" by choosing valuations similar to other analysts to protect their position in the rankings - low ranked analysts may make outlandish and contrary predictions, hoping that a lucky break will put them at the top

private equity:

- consolidates ownership - aims to improve the firms it buys - tends to use leverage for LBOs

issues with net profit

- groups cash and non-cash expenses - capital structure and tax rates make it harder to compare operations of firms - managers may have discretion in their calculation of net profit

common valuation mistakes

- ignoring incentives - exaggerating synergies and ignoring integration costs - underestimating capital intensity

what will have a negative effect on the firms cash flows?

- increase in A/R - decease in A/P increase in working capital - increase in inventory

Select all that apply when it comes to stock splits: - increases # of shares - increases share price - increases equity - decreases leverage - dilutes current shareholders - decreases share price

- increases # of shares - decreases share price

buy side

- mutual funds - pension funds - endowment funds - sovereign wealth funds - hedge funds

4 ways for a firm to allocate capital

- organic expansion - M&A - dividends - share buybacks

what are sources of value creation?

- returns to capital that exceed costs of capital - reinvesting profits to grow

disagreements between finance and accounting

- what constitutes economic returns - how to value equity

A venture capitalist offers to buy 25% of your company for $30000. what will be the estimated value of your firm if you accept the deal?

120,000

EV equation

= Market Cap (MV of equity) + MV of debt - cash

free cash flow formula

= operating income(EBIT) - taxes + D&A - change in working capital -capex

DuPont Framework

A systematic approach to identifying general factors causing ROE to deviate from normal. ROE= profitability*productivity*leverage profitability= profit margin productivity= asset turnover

What would likely change a the firm tried increasing its debt level to 90%?

As a firm takes on more debt, it becomes riskier, which leads to increased cost of debt and equity. While we assumed for these costs to remain unchanged, the assumption becomes unrealistic if the firm would take on 90% of debt.

TV equation

CF1/(r-g)

If a company pays out a special dividend using its excess cash, how does this affect EPS?

Doesn't impact operations, so net income will stay the same. EPS= net income / # shares, so it will remain unchanged.

which of the following metrics are often used as proxies for firm performance focused on cash flows?

EBITDA, operating CFs, FCF

enterprise value definition

Enterprise Value is the capital you would need to pay off financiers of the enterprise (equity holders and debt holders); in other words, it's an estimate of the cost to purchase the whole enterprise.

if a company repurchased $30 worth of shares, what numbers would change?

Equity, # shares, cash

sell side

Investment banks and other firms that sell securities to investors - traders - salespeople - investment bankers - media - mergers/ acquisitions

what is the main shortcoming of IRR

It fails to take into account the scale of a project. Hence, a smaller project with a higher IRR may still have a smaller NPV than another project.

Why does leverage sometimes get a bad rep?

Like profits, leverage also multiplies losses.

Assuming that Apple issues a special dividend, and it all comes from excess cash. Since the dividend would come from excess cash, it would have no effect on future operations (and ability to generate earnings). How would paying out the dividend affect the company's future P/E?

P/E should decrease

if disc rate > ROE

PV decreases --> lose money

If a company pays out a special dividend using its excess cash, how does this affect P/E?

Paying out dividends will reduce the share price, and since EPS hasnt changed, P/E should decrease.

which of the four pieces of the dupont framework should be most similar across different industries?

ROE

What valuation technique reduces the risk of overpaying for an acquisition?

Scenario Analysis

Despite the mechanical effect having no effect of share price, what could be a reason for equity issuance causing a decrease in stock price?

Signaling

Share buybacks tend to increase EPS

TRUE

What signal does share buyback send?

The signal of share buybacks usually means that shares are cheap. It may also be signaling that it either has too much excess cash or doesn't have many investment opportunities.

fictional metal is a gold mining company, with its A/R making up 20% of its assets. which of the following companies is most likely to owe fictional metal money as part of fictional metals A/R?

a jewelry company specializing in 24k gold.

Which would characterize best Microsoft's acquisition of LinkedIn? a. Friendly deal b. Hostile takeover c. Leveraged buyout d. Proxy fight

a) friendly deal

short selling

borrow shares from another investor(mutual fund) which charges a fee for lending to you. You sell the shares with hopes to repurchase the shares at a lower price.

free cash flows is for

all capital providers and is tax adjusted

leverage formula

assets/equity

what clouds transparency in financial markets, especially between companies and banks?

asymmetric information

which of the following is not one of the benefits associated with M&A for the buyer? a. Accelerate time to market with new products and channels b. Achieve supply chain efficiencies c. An opportunity to cash out d. Remove competition

c. An opportunity to cash out

A tender offer is most common in a. Divestitures b. Friendly transactions c. Hostile transactions

c. hostile transactions

current ratio

current assets/current liabilities - measures if a company will be able to pay suppliers if it has to close

what types of companies are more likely to have high leverage

companies with fairly consistent cash flows

who cares most about ROE

company's stockholders

which cost of capital is usually cheaper

cost of debt

cash conversion cycle

days of inventory + days of receivables - days of payables DIO= 365/(COGS/AVG INVENTORY) DSO=365/(sales/avg receive) DPO=365/(COGS/avg payables)

a different way to slice financial markets

deals(private markets) vs. public markets

MV of what is likely to be closest to the BV?

debt

which allocation decision would be asking the questions "will they get hooked? is this sustainable? what do I signal by doing this?"

dividends

for a firm with some amount of debt which beta should be the highest

equity

when management of the firm discovers a very profitable project that will surprise everyone, which of the following sources of capital should they try to avoid using to fund the investment

equity

T/F: youre the manager of a fund believing general motors is going to do well and ford will decline. you can guarentee profit by going long on GM and short on ford

false

if a company develops in-house a highly profitable treatment and secures a patent for it, the asset will most likely appear on its balance sheet as an intangible asset(goodwill)

false

if company A has a lower WACC than company B, it can create value by acquiring company B since it will apply a lower cost of capital to discounting cash flows of company B.

false

southwest has high levels of inventory

false

with time, as firms mature they tend to distribute less and retain more cash

false

when returns to capital are ________ than costs of capital value is created

greater

companies will overinvest in divisions with high/medium/low betas

high

based on P/E ratios which has the most growth opportunities?

highest P/E ratio

increasing earning retention rate will

increase M/B ratio

as a firm takes on more leverage its debt beta

increases

what type of company will have the highest amount of A/R relative to its sales?

intel (semiconductor chip manufacturer)

what companies would have a high profit margin

intel, corning glass

funding gap

inventory+days receivables-days payable

for a company with returns to capital of 5% and costs of capital of 10%, its market to book ratio will most likely be

less than 1

what comes with an explicit interest rate

long term debt

suppliers of a firm would be more anxious about a

low current ratio

the decision to time the issuance of equities or debt to market conditions is

market timing

eps=

net income/# shares

profit margin

net profit/revenue

Your company builds a new plant with an investment of $200 million and an expected present val from its future cash flows of $250 million. A year later, it becomes apparent that the new product isn't selling as well as expected, and the present value of future cash flows at that point is only worth $150 million. Should the company shut down the plant?

no because the pv is positive

activities to generate cash flows

operating, financing, investing

You are considering two projects and can only choose one: first one has IRR = 15% and NPV= 3200, second has IRR= 25% and NPV=2500. WACC is 12% for both. Which project should you choose?

project with npv= 3200 bc npv is highest.

NWC

receivables+ inventory - payables

asset turnover

reveue/assets

most equity research analysts are employed by and receive their paychecks from...

sell side firm

Breakup fee is usually paid by

seller

what risks cannot be diversified away by adding more securities to the portfolio?

systemic, non diversifiable, market

which company's long term debt is riskier?

the one with less cash

leverage can give you control over assets you would otherwise not have

true

the conservatism principle suggests that firms tend to underestimate the value of their assets and overestimate the value of their liabilities

true

which industry will have the lowest beta

utilities

when ROE > cost of capital

value is created