Corporate Conceptual
What is the difference between rights offer and a cash offer?
Cash offer is an issue of securities offered for sale to the general public on a cash basis whereas rights offer is a public issue of securities in which securities are first offered to existing shareholders.
What is the impact of financial leverage on stockholders?
Financial leverage can be beneficial to stockholders as it increases the total value of the firm. At the same time, increasing debt reducing the payoff to stockholders. This is because the firm has to payoff its debtholders first. Thus, making it riskier for stockholders.
Explain why we might expect a firm with a positive NPV investment to finance it with debt instead of equity
If a firm has a positive NPV project it should issue debt and let the existing shareholders have all the gains instead of sharing the gains from the new project with new shareholders.
What does M&M Proposition I state? What are the relevant assumptions?
MM proposition one states that the market value of the firm is independent of its capital structure. In other words, capital structure is irrelevant to the value of the firm. This is true under the following assumptions: 1. No taxes, corporate or personal. 2. No costs of bankruptcy. 3. No transactions or issuance costs. Shareholders, creditors, and managers all have the same information (i.e., no tricks can be played)
What is the difference between a marketed claim and a nonmarketed claim?
Marketed claims can be bought and sold in financial markets, but nonmarketed claims cannot
Why might firms prefer not to issue new equity?
Stock prices tend to decline following the announcement of a new equity issue, although they tend to not change much following a debt announcement. This is because of: 1. Price pressure 2. Issue Costs 3. Debt usage 4. Managerial information 5. Dilution
What are the two theories of capital structure that we learned?
The trade-off theory which suggests that managers compare the tax benefit of additional debt to the potential bankruptcy costs due to additional debt to determine the optimal debt ratio. The pecking order theory which implies that firm's prefer using internal financing to issuing debt followed by issuing equity.
What causes IPO underpricing?
There are various explanation as to why underpricing continues to exist, but researchers disagree as to which explanation is correct: • Smaller, more highly speculative issues • Young firms with few to no sales in the previous year can be very risky; they must be significantly underpriced to attract investors • Few IPO buyers will actually get the initial high average returns observed in IPOs • Winner's curse implies the average investor "wins" and gets the entire allocation because those who knew better avoided the issue • Underpricing is a kind of insurance for the investment banks Underpricing is a way the bank can reward investors for truthfully revealing what they think the stock is worth and the number of shares they would like to buy
What is the relationship between the value of an unlevered firm and the value of a levered firm once we consider the effect of corporate taxes?
Vl=Vu + TcVD Value of the levered firm is equal to the value of the unlevered firm plus the tax benefit from debt.
Should financial managers choose the firm's capital structure? If so, how?
Yes, once we relax the MM assumptions, firm managers should choose a firm's capital structure such that the firm value is maximized or the WACC is minimized.