Investment Banking and Finance Set
Median debt percentages for buyouts
55%-61%
Flexible Budget
A report showing estimates of what revenues and costs should have been, given the actual level of activity for the period.
subsidy/subsidise
A subsidy is a benefit given by the government to groups or individuals, usually in the form of a cash payment or a tax reduction. The subsidy is typically given to remove some type of burden, and it is often considered to be in the overall interest of the public.
Decision Making and Common Stock Value: Changes in Expected Dividends
-assuming that economic conditions remain stable, any management action that would cause current and prospective stockholders to raise their dividend expectations should increase the firm's value -therefore, any action of the financial manager that will increase the level of expected dividends without changing risk (the required return) should be undertaken, because it will positively affect owners' wealth
Three actors in crowdfunding
1) project initiator 2) individuals or groups who support 3) the platform that brings them together
when is an option embedded in an action?
1) right to buy or sell a specified quantity at a fixed price 2) clearly defined underlying asset whose value changes over time in unpredictable ways 3) the payoffs contingent on a specified event occurring within a finite period
Characteristics of LBO (3): leverage, management, board
1) significant increase in financial leverage (20% → 70%) 2) management ownership interest increases (10-35 % ownership) 3) non management equity investors join the board (board will have 2-3 from the LBO sponsor)
when option pricing models are used to value real asset we have to accept that...
1) value estimates that emerge will be far mor imprecise 2) the value can deviate much more dramatically from market price
variables relating to the underlying asset
1) value of the underlying asset 2) volatility of that value 3)expected dividends
Three basic questions for options analysis
1) when is there a real option embedded in a decision or asset? 2) when does the real option have significant economic value? 3) can the option value be estimated using an option pricing model
Clicker ? Which of the following is true regarding a bond? A. The face value and coupon payments of a bond NEVER change B. Only the face value of a bond can change C. Only the coupon payments of a bond can change D. Both the face value and coupon payments of a bond can change
A. The face value and coupon payments of a bond NEVER change
Maximax
An optimistic decision-making criterion. This selects the alternative with the highest possible return.
tangible asset
Assets having a physical existence, such as cash, equipment, and real estate; accounts receivable are also usually considered tangible assets for accounting purposes.
Current ratio
CURRENT ASSETS ÷ CURRENT LIABILITIES
ARR
Calculates an average percentage return on investment using financial accounting principles
Receivables (control of current assets)
Control of this current asset is important as it requires collecting sums of money due to a business from customers to whom it has supplied goods or services. This means converting them to cash at the time that they fall due.
Loans (control of current liabilities)
Control of this current liability can be undertaken by investigating and monitoring costs for establishment of loans, interest rates and ongoing charges. Control of loans involves investigating alternative sources of funds from different banks and financial institutions in an effort to minimise these costs.
Cost of Capital
Cost of capital represents the overall cost of financing to the firm.
Product Cost
Costs assigned to the manufacture of products and recognized for financial reporting when sold
Type of bond insurance
Credit Default Swap
Quick Ratio (Liquidity)
Current Assets- Inventory / Current liabilities
Current Ratio (Liquidity)
Current assets/Current liabilities
Cost controls
This is about controlling the costs that the business spends in running a business, such as production costs, marketing costs and administrative expenses.
Owners' equity
This is an internal source of finance and are the funds contributed by owners or partners to establish and build the business.
Private equity
This refers to a source of equity finance where money is invested in a (private) company not listed on the Australian Securities Exchange (ASX). The aim of the private company (like the publicly listed companies who sell ordinary shares) is to raise capital to finance future expansion/investment of the business.
New issues (ordinary shares)
This refers to a source of equity finance where new shares are sold for the first time on a public market e.g. the Australian Securities Exchange via an initial public offering (IPO).
Strategic role of financial management
This refers to the role finance managers have in making funds available for business activities and ensuring that day-to-day transactions and operations run smoothly from a financial perspective.
Mortgage
This type of long term debt finance is a loan secured by the property of the borrower (business). Mortgage loans are used to finance property purchases, such as new premises, a factory or office. They are repaid with interest, usually through regular repayments, over an agreed period of time.
standing order
Type of preauthorized-payment under which an account holder instructs a bank to pay a specified amount, directly from his or her account balance, to a named party on a regular basis
Pure risk,
a type of risk where the only consideration is the possibility of loss. Speculative risk in contrast offers the possibility of loss or gain.
One means to adjust for risk is
a. standardize funds' returns by their beta coefficients
Which financial statement is most important for an auditor?,
balance sheet - auditors audit balance sheets.
Which financial statement is most important for a lawyer?,
balance sheet - if you are suing a company it is important to understand whether the lawsuit is cost effective.
Universal bank,
bank offering financial services typical of both investment and commercial banking to consumers and small businesses as well as corporate clients.
call feature
benefits issues (bond seller), allowing them to repurchase bonds at a stated call price prior to maturity -the call price is the stated price at which a bond may be repurchased, by use of a call feature, prior to maturity - the call premium is the amount by which a bond's call price exceeds its par value -if feature benefits the issuer, it makes the bond less valuable (increases interest rate)
credit terms
can either be standard or negotiated that control the monthly and total credit amount, the payback time, discount for early payment and the late payment penalty.
the key inputs to the valuation process include
cash flow, cash flow timing, risk
when does the option have significant economic value?
for an option to have significant economic value, there has to be a restriction on competition (ex. patent) at the limit, real options are most valuable when you have exclusivity
Commodities,
goods such as oil, petrol, metal or grain.
Closed‑end investment companies
have a fixed capital structure may sell for a premium over net asset value
Closed-end investment companies with beta
have less systematic risk than the market
Sub-prime loans,
high-risk loans to clients with poor or no credit histories.
upward sloping yield curve reflects
higher reflected rates of interest
The net asset value of a closed-end investment company increases with
higher stock prices
Activity ratios measure
how rapidly assets flow through the firm
The quick ratio
includes cash and cash equivalents
Which financial statement is most important for management?,
income statement - because they must figure out how to make the most money.
Chinese walls,
information barriers within investment banks to manage potential compliance and conflict of interest issues.
Preferred stock and long‑term bonds are similar because
interest and dividend payments are fixed
A style portfolio manager offers two things
investment skill combined with the style
A real estate investment trust
invests in mortgages or rental properties
IRR
is the discount rate that equates the NPV of an investment opportunity with $0 (because the present value of cash inflows equals the initial investment); it is the rate of return that the firm will earn if it invests in the project and receives the given cash inflows complex calculation, fraught with math problems -visually and intuitively preferred -no value measurement -can rank projects if math correctly assessed
accept-reject approach
is the evaluation of capital expenditure proposals to determine whether they meet the firm's minimum acceptance criterion implies projects are independent and will unlimited funds approach to determine what projects to invest in
capital rationing
is the financial situation in which a firm has only a fixed number of dollars available for capital expenditures, and numerous projects compete for these dollars implies projects are mutually exclusive and that they will use a ranking approach to decide what projects to invest in
coupon interest rate
is the percentage of a bond's par value that will be paid annually, typically in 2 equal semiannual payments, as interest
bond's maturity date
is the time at which a bond becomes due and the principal must be repaid
outstanding shares
issued shares of common stock held by investors, this includes private and public investors authorized shares become outstanding shares when they are issued or sold to investors
Reserve requirements are rarely used as a Fed monetary policy tool because a raise causes liquidity problems for banks with ________
low excess reserves
leasehold land
means that you just have a lease from the freeholder (sometimes called the landlord) to use the home for a number of years.
IRR
Determins the rate of yeilded by a project
Dividens Payout Ratio
Dividends paid to common shareholders / Net Income available to common shares
Dividens per share
Dividends paid to shareholders / No. of ordinary shares outstanding
Interest rates (global financial management)
Domestic and international businesses will source funds internationally and will therefore need to consider these rates offered on borrowings. The repayment of this debt must also allow for fluctuations in currency.
Open market purchase
Expansion of Reserves
Operating Cycle
Inventory turnover + Recievables Collection period
Inventory Turnover Period
Inventory/ Cost of sales X 365
Risk Takers
Is highly attracted to potentially high returns. Prepared to take risks to achieve them
LBO Financing Sources
LBO sponsors have equity funds raised from pensions and insurance companies, some have mezzanine funds as well that can be used for subordinated debt
decreases in the cost of funds or in risk will do what to the required return?
LOWER
why isn't friends and family finance used more?
Lee and Persson: social costs of borrowing from friends and family, expensive in non-monetary ways to borrow from family.
Assets (equation)
Liabilities + Equity
venture capital
Money invested in a new business and thus open to a large risk of loss.
interest
Money paid to a lender for the use of borrowed money.
liabilities
Money that a company will have to pay to someone else - bills, taxes, debts, interest and mortgage payments etc.
seed / start-up capital
Money used for the initial investment in a project or startup company.
The most important policy tool for the Fed to control the money supply is _______
Open Market Operations
Inventory Flow
Opening Balance + Additions = Withdrawals - Closing balance
ROCE
Operating income / capital employed
WOULD YOU RATHER ACHIEVE A HIGH IRR OR A HIGH MOM ON A DEAL? WHAT ARE THE TRADEOFFS? WHAT FACTORS MIGHT INFLUENCE YOUR ANSWER?
PE firms try to achieve high IRRs and high MoMs on deals, but sometimes tradeoff choices between these two common returns metrics do arise. For example, let's say a PE firm bought a company for $100 and, three years later, has a choice to either sell it immediately for $180 or wait another year and sell it for $200. In this scenario the PE firm would achieve a 22% IRR and a 1.8x MoM by selling after year three versus a 19% IRR and 2.0x MoM by selling after year four. This tradeoff exists because a longer hold period counts against IRR but does not count against MoM. Two common reasons to prefer a higher IRR are: 1 • IRR is the most important single metric by which many LPs judge the performance of PE firms because LPs such as pension funds and endowments need to hit certain return rate thresholds in order to meet their commitments to their constituents. An LP won't be impressed with a 2.0x MoM if it take 10 years to materialize, because the IRR on that return would be far below the LPs requirements for the PE portion of its portfolio. Funds which achieve "top quartile" IRRs usually have little trouble raising subsequent funds, whereas funds with low IRRs struggle to raise future funds. Therefore, PE funds are careful not to let IRRs drift below the level their LPs expect. 2 • Most PE funds don't get their carried interest unless their IRR exceeds a certain "hurdle rate". Hurdle rates and the mechanics of hurdle rate accounting are varied and complicated, but most funds must clear a 6-17% IRR in order to receive their full carried interest percentage. Therefore, if a fund's IRR is below or near its hurdle rate, PE funds are especially financially incentivized to boost IRR. Two common reasons to prefer a higher MoM are: 1 • Assuming the hurdle rate has been exceeded, GPs are paid carry dollars based on MoM, not IRR. If a GP buys a company for $100 and sells it for $140 one year later, that translates to a terrific 40% IRR, but the GP would earn only ~20% * $40 = $8 in carried interest. On the other hand, if a GP buys a company for $100 and sells it for $250 after four years, the IRR falls to 25% but the carried interest earned is ~20% * $150 = $30. 2 • PE firms (and by proxy their LP investors) incur transaction costs when they buy and sell companies. If a PE firm sells portfolio companies too quickly in order to juice IRR, then it has to spend more money to find and close additional deals. In addition, once a PE firm fully invests its existing fund, it must raise another fund, which also has fundraising costs associated with it. As you can see, the choice between MoM and IRR can be complicated and involves several considerations. As a general rule PE firms prefer to hold on to portfolio companies and grow MoM as long as the annual rate of return the portfolio companies are generating meets or exceeds the rate expected by the PE firm's LPs.
Payables Payment Period
Payables / Cost of Sales X 365
Market value exceeds par
Premium Bond
Risk Averters
Prepared to forego the possibility of high returns if this means the possibility of low returns are avoided
Discounted Rate
Present Value of 1 = (1+r)~n
Cash Flow Statement
Presents the movement in cash and bank balances over a period of time
5 factors affecting FX currency
Price levels, tariffs, imports, exports, productivity
Non-Accounting Style
Prime objective is not financial, money still needs to be considered as cash is what needed to stay in the business.
Equity Financing
Provided by shareholders
Revenue
Quantity of goods sold multiplied by the selling price. TR = P x Q
increases in the basic cost of long-term funds or in risk will do what to the required return?
RAISE
profit margin
The percentage that a seller adds on to their cost price when selling a good.
External sources of finance
These are the funds provided by sources outside the business, including banks, other financial institutions, government, suppliers or financial intermediaries.
Cost centres (cost controls)
These can be used to help control costs in an effort to boost profitability. They are departments or sections within business that generate costs that can calculated and monitored.
How to calculate GROSS PROFIT
SALES - COGS
Accounts receivable turnover ratio
SALES ÷ ACCOUNTS RECEIVABLE
Another Example
Slide 15 class 28 figure it out
intangible asset
Something of value that cannot be physically touched, such as a brand, franchise, trademark, or patent.
Flexible Budget (equation)
Standard price X actual units sold
Banks
These financial institutions are the major operators in financial markets and are the most important source of funds for businesses. Banks receive savings as deposits from individuals, businesses and governments, and, in turn, make investments and loans to borrowers.
Availability of funds (global market influences)
This global market influence refers to the ease with which a business can access funds (for borrowing) on the international financial markets.
rights offering
new shares are sold to existing shareholders
bonds: PV
price of the bond
Ratio Analysis
the assessment of a firm's financial condition using calculations and interpretations of financial ratios developed from the firm's financial statements
when YTM = coupon then
the bond trades at par RARE
term structure of interest rates
the relationship between the maturity and rate of return for bonds with similar levels of risk
What do Gilge and Taillard find about private firms ability to react ti investment opportunities?
they find private firms are not as quick to react to new investment opp. because they lack the easy access to capital
market capitalisation
total value of the firm
Proprietory trading,
trading carried out using the firm's capital on its own behalf.
Market risks in FX
transaction, competition, country
LBO analysis includes:
1) cash flow projections 2) terminal value projections 3) minimum IRR analysis solves for the purchase price that will achieve the minimum IRR and considers wether there is sufficient cash flow to operate the company and pay down debt
private debt returns come from: (3)
1) cash interest 2) payable in kind (PIK) interest (borrowing just adds up to ending balance, no cash payments between) 3) Ownership: security will often include equity through attatched warrants or conversion feature similar to convertable bond
traditional models underestimate the value of investments where there are options embedded to:
1) delay or defer making an investment (delay) 2) adjust or alter production schedules as price changes (flexibility) 3) expand into new markets or products at later stages (expansion) 4) stop production or abandon investments if outcomes are unfavorable (abandonment)
Gearing (financial ratio analysis)
Measured by debt to equity ratio
Liquidity (financial ratio analysis)
Measured by the current ratio
Standard Costing
a predetermined, budgeted or expected unit cost; the amount that something should cost over a period of time.
Hedge fund,
a private investment fund that uses a range of strategies to maximise returns, including hedging.
Creditors would prefer
a quick ratio of 1.2 to a quick ratio of 0.8 days sales outstanding of 35 to a days sales outstanding of 46
Leveraged Buyout
acquisition of a company or division of a company using equity from a small group of investors and a significant amount of debt.
Hedging
This is a global management strategy that is implemented to minimise the risk of currency fluctuations.
Financial risk (planning and implementing)
This is a part of planning and implementing that involves assessing the risk to a business of being able to cover its financial obligations.
Normalised earnings (limitation of financial reports)
This limitation to financial reports refers to earnings being adjusted in financial reports to take into account changes in the economic and remove one-off factors.
Payment in advance (method of international payment)
This method of international payment allows the exporter to receive payment and then arrange for the goods to be sent.
The amount of the discount on a bond moves directly as to the longer the term to maturity
True
The securitization of the mortgage industry increased systematic risk to the lender
True--
a $60,000 outlay for a new machine with usable life of 15 years is called
capital expenditure because it is expected to produce benefits over a period of time greater than 1 year
bonds: FV
face value (terminal, maturity, par) always 1000
Preferred stock dividends are
not a legal obligation not exempt from federal income taxation
solvency ratio
total assets - external liabilities / total assets
Special situations
providing capital for risky and challenging corporate events (spin-offs, litigation asset sales etc.)
Leveraged buy out (LBO),
takeover of a company funded by high-risk bonds or loans.
The "too big to fail" policy reduce the adverse selection problem in bank regulation
False
Operating Cash Flow
Profit + Depreciation
Commercial paper is generally
a short-term unsecured debt of a corporation
Seed/startup
small amount of capital, focus on product development and market research
perpetuity
annuity that goes on forever P= CF/I
Market maker,
bank that is obliged to offer to trade securities in which it is registered throughout the trading day.
Budget
A detailed plan of income and expenses expected over a certain period of time
The Federal Reserve Banks have four of their presidents on the Fed open market committee (FOMC)
False
The main advantage of quantitative leasing is that purchase of short term securities could reduce longer-term interest rates
False
A point on a mortgage loan refers to one monthly payment of principal and interest
False--
Mortgage interest rates loosely track interest rates on three-month Treasury bills
False--
PMI (Private Mortgage Insurance) is an insurance policy that allows the lender to receive the difference between the value of the property and the sale amount
False--
Price stability
Fed Goal
Efficiency (financial ratio analysis)
Measured by the accounts receivable turnover ratio
Efficiency (financial ratio analysis)
Measured by the expense ratio
Profitability (financial ratio analysis)
Measured by the gross profit ratio
Profitability (financial ratio analysis)
Measured by the net profit ratio
Profitability (financial ratio analysis)
Measured by the return on equity ratio
how did glass steagall act limit availability of PE
the act made banks choose between a depository bank and investment bank, so banks could not invest their depository assets in PE
liquidity
the degree to which an asset can be bought or sold quickly in the market without affecting the asset's price.
Payment only at maturity
zero coupon
Depreciation
(Investment-residual) / Life
Operating Profit Margin
(Operating profit ÷ Total revenue) X 100
gross profit
Revenues minus the cost of goods sold.
Current assets
These appear on the balance sheet and are items of value owned by the business that can be turned into cash within 12 months. They usually include cash and accounts receivable.
Valuing assets (limitation of financial reports)
This limitation to financial reports refers to the difficulty in placing a value on some assets, which creates areas that businesses can exploit to create a misleading impression of their financial position.
Conflict between short-term and long-term objectives
This refers to the conflicts between these objectives. Improving one financial objective makes other financial objectives worse. For example, maintaining higher levels of liquidity means sacrificing potential opportunities for growth and profitability.
Sources of finance
This refers to the different ways that businesses can obtain money to perform business activities such as paying suppliers and buying equipment. They can be classified as internal sources (eg retained profits) and external sources (eg debt and equity).
Which of the following is not an investment company?
a commercial bank
authorized shares
shares of common stock that a firm's corporate charter allows it to issue
Toxic debt,
shorthand for types of assets that have caused severe problems for the financial institutions that held them since the onset of the credit crunch. US sub-prime mortgage debt was the original toxic debt.
Options,
similar to futures, but provide the buyer with the right rather than the obligation to complete the contract.
insolvency
situation where an entity cannot raise enough cash to meet its obligations, or to pay debts as they become due for payment company needs to sell off any assets to pay outstanding debts
security interest
a provision in the bond indenture that identifies any collateral pledged against the bond and how it is to be maintained. The protection of bond collateral is crucial to guarantee the safety of a bond issue
Gilts,
bonds issued on behalf of the UK government to fund spending. Known as 'gilt-edged securities' because the bond contracts used to have gold round the edge.
as volatility increases
both call and puts value ↑
Spread,
difference between bid and offer price - one way in which banks make profits.
Clicker ? The ________________ the maturity of a bond and the ___________ the coupon rate, the more sensitive the bond is to interest rate fluctuations A. Longer, lower B. Longer, higher C. Shorter, lower D. Shorter, higher
longer; lower
The debt ratio is a measure
of financial leverage of the use of debt financing
Early Stage
products are mostly in testing or pilot productions. companies are in business for three years or less
The advantages offered by investment companies include
professional management portfolio diversification
sinking fund requirements
restrictive provision often included in a bond indenture, providing for the systematic retirement of bonds prior to their maturity
rewards-based
rewards offered but not in the form of equity. creators maintain ownership
level of interest rates: as rates ↑
right to buy becomes more valuable, right to sell becomes less valuable
as value of underlying asset increases
right to buy value ↑ right to sell value ↓
as interest rates go up, more demand, currency _____
rises
as tariffs increase, currency _______
rises
Bid price,
the price at which the market maker will buy.
capital budgeting
the process of evaluating and selecting long-term investments that are consistent with the firm's goal of maximizing owner wealth
Debt, preferred stock, & common stock all determine
the prospective weightings of each components
ranking approach
the ranking of capital expenditure projects on the basis of some predetermined measure, such as the rate of return implies projects are mutually exclusive and are using capital rationing approach to determine what project to invest in
Venture debt
typically used by VC backed companies that are in between financing rounds (1-2 yrs)
Mezzanine
used by companies that are cash flow positive to fund further growth through expansion projects, acquisitions, recaps. Subordinate to senior debt but senior to equity
APV method
useful when a firm's capital structure is changing (LBOs) or a firm has NOLS. Value pretending firm is all equity and then add sublayers.
Leveraging,
using debt to supplement investment. An institution that has borrowed heavily in addition to its funds or equity to finance growth is said to be highly leveraged.
accuracy of pre and post money valuation
usually an over estimation. arises because the reported valuations assume all of the companies shares have the same price as most recently issued shares. but more recent shares always have better cash flows then previous ones
as dividends increase
value of call ↓ value of put ↑
valuing a firm with patents
value of firm = value of commercial products (using DCF value) + value of existing patents (using option pricing) + value of patents that will be obtained in future - cost of obtaining those patents.
risk premium
varies with specific issuer and issue characteristics because the Treasury bond would represent the risk-free, long-term security, we can calculate the risk premium of the other securities by subtracting the risk-free rate
Initial Coin Offerings
way for startups to make money by selling tokens. have raised 1.2B so far and now surpass early stage VC funding for internet companies. common uses: data storage, dental work attracting attention of SEC. Should they be regulated at securities?
option to delay
when a firm has exclusive rights to a project it can delay until a later day. fact that project does not pass muster today does not mean that the rights to the project are not valuable
Profit & Loss Account (P&L)
A financial statement showing a company's net profit or loss in a given period.
Why would a company issue debt instead of equity?
"I. Debt does not dilute the shareholders interest in the company. II. Interest on debt can be deducted on the company's tax return. III. A lender is only entitled to repayment of the principal amount and interest and has no direct claim to future company profits. IV. Except for variable rate loans, debt can be planned, while equity cannot.
A mutual fund with a beta coefficient of 0.8
. has less systematic risk
cost of debt (2 components)
1. after-tax (must find before tax to find after unless after tax is given) 2. flotation costs ri= after tax rd=before tax ri = rd * (1 - T) riskier companies have higher rate or debt
Year of Creation of FDIC
1913
Year of Allowed Bank Interstate Branching
1933
Year of Creation of Fed
1980
FED guideline for taking out debt
6x Ebitda
Median EBITDA multiples for buyouts
8-10.7x
cost of common stock equity
= rs is the rate at which investors discount the expected dividends of the firm to determine its share value aka required rate of return rs = Rf + b * (rm -Rf) rs = D1/P0 + g
Cost Plus Pricing
A Method used to determine how goods and services are priced. Priceing an item you are seeling based on the wholesale price you paid for it.
mortgage
A bank loan secured by property
Zero-based Budget
A budgetary approach that assumes the base for projecting next year's budget is zero; managers are required to justify all activities and every proposed expenditure.
WACC: - What do you need to know for PE interviews? - One wrinkle in the WACC formula? - What is the WACC formula
A lot can be said about WACC. For PE interviews you just need to know WACC is a measure of the riskiness of investing in a company. It is used as the discount rate in the denominators of the DCF equation. The TEV of every company is made up of some percentage equity and some percentage debt. Therefore, the WACC is the sum of the cost of equity and the cost of debt, each weighted by the percentage of TEV they constitute. One wrinke: Interest payments on debt are tax deductible (this is referred to as an Interest Tax Shield or ITS), so the cost of debt must be adjusted by multiplying it by one minus the tax rate. Simplest way to estimate the cost of equity is to apply the CAPM model (see the section on Cost of Equity). The simplest way to estimate the cost of debt is to use the yield on the company's debt (i.e. what % interest the company pays on its debt). The WACC formula = (Market Cap. Equity / TEV)*(Cost of Equity from CAPM) + (face value of debt / TEV)*(Yield on debt)*(1 - Tax Rate)
Liablilties (equation)
Assets - Equity
Income / revenue / turnover
All the money received by a person or company during a given period.
fixed / non current asset
An asset that is not consumed or sold during the normal course of business, such as land, buildings, equipment, machinery, vehicles, leasehold improvements, and other such items.
asset
Any item of economic value owned by an individual or corporation, especially that which could be converted to cash. Examples are cash, securities, accounts receivable, inventory, office equipment, real estate, a car, and other property.
Assets
Anything of value that is owned by the firm e.g cash, inventory, machines ( current asset: likely to be used up or converted into cash within one business cycle)
expenditure
Ausgaben
Replaced by registered bonds
Bearer bonds
State of the economy
Beige Book
Two past chairmen of the Fed prior to Yellen
Bernanke, Greenspan, Volcker, Martin
Staggered appointments
Board of Governors
Inventories (control of current assets)
Control of this current asset generally seeks to minimise levels because inventory ties up cash and incurs costs such as storage costs and the potential for theft.
Cash (control of current assets)
Control of this current asset is critical for business success as it ensures that the business can pay its debts, repay loans and pay accounts in the short term, and that the business survives in the long term.
IF YOU COULD CHOOSE TWO OF THE THREE FINANCIAL STATEMENTS IN ORDER TO EVALUATE A COMPANY WHICH WOULD YOU CHOOSE AND WHY?
Choose the income statement and the balance sheet because if you have them, you can actually build the CFS yourself. Remember that cash flow is basically equal to Net Income, plus/minus noncash items on the income statement, plus rise in liabilities on the balance sheet, minus rise in assets on the balance sheet.
Fed Functions (6)
Clearing checks, issuing currency, regulation, issuing discount securities, M&A approval of banks, research
Absorption Costing
Closing stock = opening stock + production units- sales units
Payables
These are sums of money owed by the business to other businesses from whom it has purchased goods and services. Payables are recorded as accounts payable.
current liabilities
Definition: All liabilities which have to paid due the next year, for example unpaid taxes or dividends. Example: The current liabilities of Vodafone are 20 million $, which is 30% of the total liabilities.
Clicker ? Which of the following should financial managers consider when making decisions? A. Expected dividends B. Expected dividend growth C. Risk D. All of the above
D. all of the above
if dividend has been paid then ____________; if it will be paid ______________
D0, D1
Long term unsecured debt
Debenture
Break-Even(equation)
FC/Contribution per Unit
Incremental Budget
Form of budgeting in which the prior budget is the basis for allocation of funds.
Debt Financing
Funds provided banks or bond holders, who receive loan contacts and publicly traded bonds in return for their money
What is GAAP ?
GAAP (generally accepted accounting principles) is a collection of commonly-followed accounting rules and standards for financial reporting.
HOW DO YOU GAUGE INDUSTRY STABILITY
Gauging stability • The stability and predictability of an industry is usually easy to gauge by determining its growth drivers and examining its performance over a few business cycles. • If the growth drivers depend on entrenched secular trends (e.g. the healthcare industry in a country with a demographically aging population) then the industry will be more predictable than one which depends on taste/trends/fads (e.g. fashion brands). • If the products the industry produces are "must haves" for customers (e.g. electricity or food staples), then the industry will be more resistant to recessions than an industry which produces luxuries (e.g. cruise lines or expensive cars). • If the products the industry produces are commoditized, then its fortunes tend to oscillate with the business cycles of its customers (e.g. mining or semiconductors), whereas industries with strong intellectual capital/differentiation tend to be less cyclical (e.g. enterprise software or medical devices).
Margin of Saftey
How much output can fall before a company reaches its breakeven point.
share subscription
If a company raise new share capital, the public or investors are able to buy shares of the company.
freehold land
If you own the freehold, it means that you own the building and the land it stands on outright, in perpetuity. It is your name in the land registry as "freeholder", owning the "title absolute".
TELL ME WHY EACH OF THE FINANCIAL STATEMENTS BY ITSELF IS INADEQUATE FOR EVALUATING A COMPANY?
Income Statement • The income statement alone won't tell you whether a company generates enough cash to stay afloat or whether it is solvent. You need the balance sheet to tell you whether the company can meet its future liabilities, and you need the cash flow statement to ensure it is generating enough cash to fund its operations and growth. Balance Sheet • The balance sheet alone won't tell you whether the company is profitable because it is only a snapshot on a particular date. A company with few liabilities and many valuable assets could actually be losing a lot of money every year. Cash Flow Statement • The cash flow statement won't tell you whether a company is solvent because it could have massive long-term liabilities which dwarf its cash generating capabilities. • The cash flow statement won't tell you whether the company's ongoing operations are actually profitable because cash flows in any given period could look strong or weak due to timing rather than the underlying strength of the company's business.
Terms of a bond issue
Indenture
External Liabilities
Loan Capital + Current liabilities
Libor,
London Inter Bank Offered Rate. The rate at which banks offer money to each other.
Which of the following is true?
Mutual funds report returns before adjusting for taxes.
Receivables Collection Period
Receivables/ Revenues X 365
Net working capital
Refers to the difference between current assets and current liabilities. It represents those funds that are needed for the day-to-day operations of a business to produce profits and provide cash for short-term liquidity.
Cash inflows (examples)
Sales, cash payment for accounts receivable, commissions received, sales of assets, proceeds from issue of shares, interest received (investments/loans) and dividends received.
WALK ME THROUGH THE PE INVESTMENT PROCESS
See the sections Deal process, Deal Selection, and Deal Funnel. Walk the interviewer through the process from sourcing to closing at a high level in ~2 minutes. No need to touch on every detail. If the interviewer wants more details he/she will ask
Regret
Selecting the alternative which will minimise the worst possible feelings of regret
Contribution
Selling price per unit - Variable Costs
Expense ratio
TOTAL EXPENSES ÷ SALES
Debt to equity ratio
TOTAL LIABILITIES ÷ TOTAL EQUITY
NPV (equation)
Takes the overall value of Asset - Initial Investments. Overall Value is the cash flow X PV factor
Income Statement
The American name for the financial statement which shows the profit or loss made by a company during the accounting period.
HOW WOULD YOU GAUGE HOW ATTRACTIVE AN INDUSTRY IS?
The three most important measures of an industry's attractiveness are: - growth rate - stability - profitability Attractive companies can also exist in unattractive industries if they have a strong competitive advantage. For example, the airline industry is low growth, cyclical, and unprofitable, but Southwest Airlines has been successful for many decades due to their differentiated business model. Even unattractive companies in unattractive industries might sometimes make good investments if you can buy them at the right price and/or remedy some of what ails them.
goodwill
The value to an established firm of its loyal customers, skilled staff and management; the value of a firm above its net value.
Debt Ratio
Total Debts/ Total Assets
TEV: - Calculation - What does it measure - How are each of its components calculated?
Total Enterprise Value (TEV) = Value of Equity + Value of Debt - Excess Cash. TEV measures the financial value of a company to all financial stakeholders: all equity holders and debt holders. Equity holders are obviously owners because they control the company, but debt holders are also owners in a sense because they could gain ownership/control of the company if it fails to make interest payments or repay principal on time. Equity Value: usually calculated using the market value (market capitalization) of a company. Debt Value: Total face value of outstanding debt on the balance sheet. Excess cash: Cash on the balance sheet which is not needed for the ongoing operation of the business.
Profit
Total Revenue - Total Costs
Payback (equation)
Use the year that cumulative cashflow turns positive/ Will turn positive. Cashflow+ Cumulative cashflow/ The year in which payback occurs
Managerial Accounting
Using financial reports for internal uses.
Birth of Silicon Valley
WW2- Berkely experimental physics research lab WW2- secret research lab run by Fred Terman at Stanford to work on student comapnies to help militray. began silicon valley 1956- William Shockley fonds shockley transitor (people left to found other companies) west begins to attract financial attention with first IPOs. Varian and HP ('56-'57)
Investment Apprasial
Ways to evaluate future cash flows than profits due to profits being subjective and cant be spent.
WACC
WdRd (1-t) + WpRp + WeRe
Balance Sheet of Wealth
Wealth = Assets - Liablilities
What is WACC ?
Weighted Average Cost of Capital.
Liabilities
What the business owes to others (debts) (Current liabilities must be put within a year, are short term debt financing)
Fianncial Asset
What the investor in the firm owns e.g a share or a debenture.
bonds: rate
YTM, or rate of return semi-annual rate= YTM*2
Investment bank,
a bank providing financial services for governments, companies or very wealthy individuals, as compared to commercial banks, which provide loans and savings accounts to the general public.
Stagflation,
a combination of stagnation and inflation, when economic growth slows as prices continue to rise.
cost to hedge
difference between spot and forward rate
HOW WOULD YOU GAUGE A COMPANY'S COMPETITIVE POSITION?
• Market share: High market share relative to competitors is usually a sign of competitive strength. Firms with higher market share are more likely to enjoy brand awareness, close relationships with key customers/suppliers, economies of scale, etc. Recent share trends also matter. Companies which are gaining share tend to be better positioned competitively. • Profit margins: High profit margins (such as Gross Margin, EBIT Margin, Net Income %, etc.) are frequently a sign of competitive strength. Companies with higher margins are usually more cost efficient and/or able to charge premium prices due to a superior product offering. Recent expansion of margins is also frequently a positive signal. • Brand perception: Brand awareness can be a very important competitive strength indicator, especially for consumer-facing businesses. Equally important is how customers perceive the brand when they are aware of it. The best signal of competitive strength is high unaided customer awareness, associations with positive attributes customers care about most, and a high willingness to recommend the brand to friends and family. • Product breadth and quality: In many industries it is important for competitors to carry a full line-up of products that can meet all or most of customers' needs. For example, a farm equipment manufacturer should probably manufacture not only tractors, but also tillers, harvesters, and many other things a farm equipment wholesaler/retailer is likely to carry. It is equally important, of course, that the products and services a company offers are well designed, well manufactured, and highly regarded by customers. • Management team quality: A bad management team can ruin the best business. A good management team can sometimes work miracles. Assessing management team strength is highly subjective, but it's something PE professionals spend a lot of time discussing. Other signs of competitive strength: •• Lowest-cost product / service delivery model •• Strong intellectual property (IP) such as patents •• Low levels of customer "churn" (customers rarely stop being customers) •• Excellent physical locations (important for retail companies) •• Diversified customer and supplier base •• Diversified revenue sources •• High levels of recurring revenue
Higher option price implies a lower comparable interest rate
Convertible Bond
Clearing,
the mechanism for making transactions happen
Stock dividends increase
the number of shares outstanding
Selling expenses
These are expenses that relate to the process of selling the good or service (eg advertising).
EBIT
earnings before interest and taxes
Earnings are
retained and/or distributed
to copy a put...
sell stock and lend
bonds: N
# of periods N= years *2
Price-to-Earnings Ratio
Price per Share/EPS
stockholder return > expected return
increase in share price
Uncertainty
Has several possible outcomes. There is not enough past experience to predict outcomes
LBO candidate characteristics (8)
1) history of profitability 2) predictable cash flows to service financing 3) low current debt and high excess cash 4) readily separable assets or businesses 5) strong management team 6) known products, strong market position 7) little danger of technological change 8) low-cost producers with modern capital
common sources of LBO Value creation (4)
1) management alignment with shareholders and agency cost effects (no free cash, management must perform to avoid bankruptcy) 2) wealth transfer (from lower salaries and benefits of employees and from gov. in form of tax benefits) 3) asymmetric information reduced 4) efficiency: more efficient decision process as private firm.
Private debt types (5)
1) venture debt 2) special situations 3) mezzanine 4) distressed debt 5) direct lending
Marginal Costing
Contribution - fixed overheads - fixed non-manf costs
Simple Apportionment Method
Total production overheads / total no. of units
debtor (GB) / accounts receivable (US)
amounts of money owed by the customer for goods or services purchased on credit
Angel Financiers
an individual who invests their own capital in a business start-up. fills the gap in seed funding between friends and family
way to calculate before-tax
calculating the cost: find the before-tax of debt by calculating the YTM generated by the bond cash flows FV = -1000 PMT = -(coupon rate *1000) N = # of years PV = price of bond - flotation (if % then = % * 1000) Rate (YTM) = ???
Which financial statement is most important for an investor?,
cash flow - because the analysis of share value will be predominantly based on cash flow.
Cumulative voting permits a stockholder to
cast the total number of votes for one individual
Which of the following is a cash inflow?
collecting an account receivable
Insider dealing,
criminal offence made by trading on knowledge of non-public information.
current ratio
current assets/current liabilities
common stockholders expect to earn a return by receiving
dividends
When rates go up, bonds go
down (inverse relationship)
Analysis of preferred stock uses
earnings after taxes
1989 flat yield curve
expectation of moderating inflation offsets the requirement for a higher rate to compensate for tying up cash -rates dont vary much at different maturities
2007 valuation rules
fair value (exit price)= the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date
Late Stage
fairly stable growth rate, more likely to be profitable, positive cash flow
Crowdfunding
funding a project or venture by raising monetary contributions from a large number of people. (statue of liberty)
Securities,
generic term for bonds, gilts and equities.
Mutual funds with beta coefficients greater than 1.0
have more systematic risk than the market
Private equity,
high risk and high return investment, holding large stakes in illiquid companies.
An American investor may take a position in foreign equities by acquiring
iShares specializing in foreign country indexes, international mutual funds country closed-end investment companies
equity-based
in return for their investments, investors receive partial ownership in the company. The JOBS Act passed in 2012 allows for investments by non-accredited investors through exemptions to existing laws
consul
infinite bond
As times‑interest‑earned increases,
interest payments become more assured
Open‑end investment companies
issue new stock whenever investors buy shares
treasury stock
issued shares of common stock held by the firm; often these shares have been repurchased by the firm
If a closed-end investment company sells for a discount,
its price is less than the net asset value
to plough/plow back
keep profit inside the company instead of spending it
Current State
many boom and bust cycles. public stock markets matter. higher stock prices are related to more IPO's and M&A activity providing more exits for PE investors
The interest rate on a residential mortgage loan is determined by what three factors
market rates, term, discount points
share premium
market selling price - nominal value
working capital
money available to a company for day-to-day operations. Generally, a measure of both a company's efficiency and its short-term financial health. Working capital is calculated as: Working Capital = Current Assets - Current Liabilities
Settlement,
once a deal has been made and clearing taken place, stock and cash transfer between seller and buyer.
40% of capital provided to VC firms comes from __________
pension funds
Analyst,
person who studies an industry sector and makes BUY, HOLD and SELL recommendations. Also, a different term referring to entry-level career position in many investment banks.
with one price, currencies will have an equilibrium establishing a base
purchase power parity
quick asset ratio
quick assets (cash and debtors) /current liabilities (share premium account)
equation for nominal rate of interest
r1= r* + IP + RP1 (r* + IP = risk free rate, Rf) (RP1 = risk premium) nominal rate can be viewed as having 2 basic components 1. risk-free rate of return, Rf 2. risk premium, RP1 r1= Rf +RP1
capital injection
raising capital by for example issuing new shares or selling current assets, short term source of finance
free float
refers to the number of outstanding shares that are available to the public for trade.
weighted average cost of capital (WACC) ra
reflects the expected average future cost of capital over the long run; found by weighting the cost of each specific type of capital by its proportion in the firm's capital structure ra = (wi * ri) + (wp * rp) + (ws * rr or n) wi = proportion of long-term debt in capital structure wp = proportion of preferred stock in capital structure ws = proportion of common stock equity in capital structure wi + wp + ws = 1
If a firm has substantial excess cash, it may
repurchase some of its shares, increase its cash dividends
zero-growth stock
stock that does not anticipate a dividend change assumes that the stock will pay the same dividend each year, year after year P0 = D1/rs the equation shows that with zero growth, the value of a share of stock would equal the present value of a perpetuity of D1 dollars discounted at a rate rs
preferred stock
stock that has a permanent dividend
An index fund limits its portfolio to
stocks included in an aggregate measure of stock prices
methods companies actually use
survey as CFOS resulting in 76% IRR 75% NPV
what is the advantage of NPV
takes into account the time value of investors' money
market capitalization
total value of a company's shares (par) value at a given moment
Debt-based
the entrepreneur or company borrows money and must repay it.
The cost of investing in a mutual fund includes
the loading charges commissions when the fund buys and sells securities management fees
Capital markets,
the market for long-term funding, eg bonds and equity.
yield to maturity (YTM)
the rate of return that investors earn if they buy a bond at a specific price and hold it until maturity (assumes that the issuer makes all scheduled interest and principal payments as promised) the yield to maturity on a bond with a current price equal to its par value will always equal the coupon interest rate when the bond value differs from par, the YTM will differ from the coupon interest rate
real rate of interest
the rate that creates equilibrium between the supply of savings and the demand for investment funds in a perfect world, without inflation, where suppliers and demanders of funds have no liquidity preferences and there is no risk -changes with changing economic conditions, tastes, and preferences
Earnings per preferred share are
the ratio of earnings to number of preferred shares
Credit crunch,
the term that has come into common usage to refer to a severe shortage of money or credit. The start of the global credit crunch can be dated to August 2007 when default rates on sub-prime loans in the US housing market rose to record levels.
in calculating cost of common stock
the use of the constant-growth valuation model is often preferred because the data required are more readily availableq
share issue
to offer shares on the stock market
goal of an LBO
to use the target company to finance the purchase, LBO analysis is based on cash flow projections and takes a company's leveraged capital structure into consideration.
conclusion using pricing models to value expansion projects
will yield extremely noisy estimated and may attach wrong premiums to DCF estimates
conclusion using pricing models to patents
you can estimate the value of the real option but the quality of your estimate will be direct function of your inputs. works better for publicly traded firms
What does a cashflow statement show?,
"The statement adjusts the Net Income of the firm for any non-cash expenses. Using the changes in the balance sheet it accounts for change in cash per period. The cash flow statement shows the net change in cash balance from start to end of the period.
Clicker ? If dividends are to remain constant at $3 and the required rate of return is 10%, using the dividend growth model, what is the stock's intrinsic value? a. $20 b. $30 c. Only the market can determine price d. Not enough information given
$3/10% = 30 B.
Gross Profit Margin
(Gross Profit ÷ Sales Turnover) × 100%
How do you calculate Free Cash Flow?,
(Net Income +- Changes in Asseets and Liabilities + Non-Cash Expenses) - (Current Property, Plants & Equipment - Past Property Plants & Equipment + Depreciation)
Traditional Method
- Calculate total direct labour hours - Work out OAR by Total Production overheads/ no. of direct labour hours - No. of units X OAR
What makes an ideal LBO candidate? Provide 4 factors
- Price is the most important factor because almost any deal can work at the right price - but if the price is too high, the chances of failure increase substantially. - Stable and predictable cash flows are important, - There shouldn't be a huge need for ongoing CapEx or other big investments - There should be a realistic path to exit, with returns driven by EBITDA growth and Debt paydown instead of multiple expansion.
Multi-stage Appointment
- Share each production overhead in various overheads - Take the 'non-productive' costs and split them amount 'productive' departments
importance of WACC
- a weighted average cost of capital is the rate of return expected by all stakeholders -the shareholders (owners) of the firm are in last position, so they receive any residual return
Changes in risk
-any measure of return consists of 2 components: a risk-free rate and a risk premium -any action taken by the financial manager that increases the risk shareholders must will also increase the risk premium required by shareholders, and hence the required return -additionally, the required return can be affected by changes in the risk free rate - even if the risk premium remains constant
common stock valuation
-common stockholders expect to rewarded through periodic cash dividends and an increasing share value -some of these investors decide which stocks to buy and sell based on a plan to maintain a broadly diversified portfolio -other investors have a more speculative motive for trading - they try to spot companies whose shares are undervalued meaning that the true value of the shares is greater than the current market price -these investors buy shares that they believe to be undervalued and sell shares they think are overvalued (the market price is greater than the true value)
PIPE Investment market reaction
-generally a negative market reaction, not good news for shareholders -hedge funds have gotten in trouble for pipe investing and then shorting that companies stock
issuing common stock
-initial financing for most firms typically comes from a firm's original founders in the form of a common stock investment -early stage debt or equity investors are unlikely to make an investment in a firm unless the founders also have a personal stake in the business -initial non-founder financing usually comes first from private equity investors -after establishing itself, a firm will often "go public" by issuing shares of stock to a much broader group
Differences Between Debt and Equity: Tax Treatment
-interest payments to debtholders are treated as tax-deductible expenses by the issuing firm -dividend payments to a firm's stockholders are not tax-deductible - the tax deductibility of interest lowers the corporation's cost of debt financing, further causing it to be lower than the cost of equity financing
WACC weighting schemes
-is for future cash flows, therefore, the prospective cost of capital is the correct weighting -equity: # of shares outstanding times market price per share -debt - during periods of stable interest rates, balance sheet debt approximates the market value
sources of long-term capital
-long-term debt -preferred stock -common stock equity -common stock -retained earnings
Comparing NPV and IRR Techniques: Which approach is better?
-on a purely theoretical basis, NPV is better because -NPV measures how much wealth a project creates (or destroys if the NPV is negative) for shareholders -certain mathematical properties may cause a project to have multiple IRRs - more than one IRR resulting from a capital budgeting project with a nonconventional cash flow pattern; the maximum number of IRRs, for a project is equal to the number of sign changes in its cash flows despite its theoretical superiority, however, financial managers prefer to use the IRR approach just as often as the NPV method because of the preference for rates of return
cost of capital
-represents the firm's cost of financing, and is the minimum rate of return that a project must earn to increase firm value -financial managers are ethically bound to only invest in projects that they expect to exceed the cost of capital (rate of profit) -the cost of capital reflects the entirety of the firm's financing activites -most firms attempt to maintain an optimal mix of debt and equity financing -to capture all of the relevant financing costs, assuming some desired mix of financing, we need to look at the overall cost of capital rather than just the cost of any single source of financing
Differences between Debt and Equity: Claims on Income and Assets
-stockholders' claims on income and assets are secondary to the claims of bondholders - their claims on income cannot be paid until the claims of all creditors, including both interest and scheduled principal payments, have been satisfied -because stockholders are the last to receive distributions, they expect greater returns to compensate them for the additional risk they bear
Common Stock: Ownership
-the common stock of a firm can be privately owned by a private investors, closely owned by an individual investor or a small group of investors, or publicly owned by by a broad group of investors -the shares of privately owned firms, which are typically small corporations, are generally not traded; if the shares are traded, the transactions are among private investors and often require the firm's consent -large corporations are publicly owned, and their shares are generally actively traded in the broker or dealer markets
comments on capital structure
-the correct portions of debt vs equity are always uncertain. the following comments can, however, be made -higher tax rates give preference to debt -higher business volatility gives preference to equity -greater operational leverage (fixed costs) gives preference to equity -greater information asymmetry gives preference to debt -stupid people are only willing to pay a lower price per share, which is a higher rate of return, which is a higher risk
pros and cons of payback analysis
-the major weakness of payback period is that the appropriate payback period is merely a subjectively determined number -it cannot be specified in the light of the wealth maximization goal because it is not based on discounting cash flows to determine whether they add to the firm's value - a second weakness is that this approach fails to take fully into account the time factor in the value of money -a third weakness is its failure to recognize cash flows that occur after the payback period
dividends
-the payment of dividends to the firm's shareholders is at the discretion of the company's board of directors -dividends may be paid in cash, stock, or merchandise -common stockholders are not promised a dividend, but they come to expect certain payments on the basis of the historical dividend pattern of the firm -before dividends are paid to common stockholders any past due dividends owed to preferred stockholders must be paid
Differences Between Debt and Equity: Maturity
-unlike debt, equity capital is a permanent form of financing -equity has no maturity date and never has to be repaid by the firm
ways to values a company (5)
1) NPV Method 2) APV method 3) comparables 4) venture capital method 5) options
Types of crowd funding
1) Rewards-based (GoFundMe, Kickstarter) 2) Equity based (EquityNet, Wefunder) 3) Debt-based (Lending Club, Prosper, Funding Circle)
Stages of Financing
1) Seed/startup 2) Early stage 3) Mid stage 4) late stage
characteristics specific to VC (3)
1) a VC takes an active role in monitoring and helping companies in its portfolios 2) VCs primary goal is to maximize its financial return by exiting with an IPO 3) a VC invests to fund the internal growth of companies
Reasons to be public company
1) access to more capital 2) publicity/recognition
Cycles and performance (3)
1) acquirers overpay when access to credit is easier, and suffer worse returns 2) buy stuff w/ cheap debt and arbitrage the dif. with equity markets 3) investments made at market peaks tend to underperform
Motivations for LBO
1) benefiting from debt financing (debt magnifies your returns) 2) eliminating operational inefficiencies 3) creates immediate shareholder value for old shareholders 4) expect good exit opportunities 5) combine companies 6) expropriate other stakeholders (employees, lower tax bill)
APV steps
1) calculate cost of equity, cash flow, terminal value, as if firm were unlevered 2) calculate value of interest tax shield 3) calculate value of nols 4) add everything up
Biggest private firms (U.S)
1) cargill 2) koch 3) albertson
Why do we need private equity (4)
1) discipline public companies managers 2) invests in companies that other investors are unwilling to fund 3) banks can't own equity and are unwilling to lend due to usary laws 4) guidance and networked expertise
venture capital method
1) estimate value in the future using multiple 2) discount back at high discount rate (leaves room for error + service charges) 3) required final % ownership= investment/ TV 4) required current ownership = required final %/ retention ratio
investor perspective on private equity
1) illiquid/decentralized market 2) large transaction costs 3) hard/subjective valuation 4) long (10+ yr) horizon 5) complex contracts
investor perspective on public equity
1) liquid market 2) small transaction costs 3) easy valuation 4) immediate horizon 5) standard contracts
Reasons to be private company
1) much less disclosure 2) less time spent managing shareholder expectations 3) manager/shareholder interest alignment
pricing test for expansion project: underlying asset, option, cost.
1) no trading have to estimate value and volatility 2) licenses are sometimes bought and sold, but more diffuse options are not 3) cost of exercising option is not known with any precision
key issues in private to private transaction (3)
1) often neither party is diversified, risk and return models that focus on just the risk that cant be diversified will underestimate discount rates 2) the investment is illiquid, need illiquidity discount 3) key person value: presence of current owner is key to value
pricing test for patents: underlying asset, option, cost of exercising
1) patents are not publicly traded, so you need to estimate the PV and volatilities 2) patents are bought and sold, but not frequently 3) cost of converting the patent for commercial production. drug firms can easily estimate
transactions that require private valuations (4)
1) private to private 2) private to public 3) private to IPO 4) private to VC to Public
differences in valuations to private vs. public investors (4)
1) shorter termism 2) need price pop for intial valuation (public) 3) synergies (financial v strategic) 4) diversification (for public) lack of diversification for private
Reasons to value a company (2)
1) show valuations (curiosity, legal reasons, compensation) 2) transaction valuations (sale to public/private investor)
Objectives for CVC (2)
1) strategic = be part of the future, foothold 2) financial = good at picking winner sin the industry
variables relating to option
1) strike price (right to buy (sell) at fixed price become more (less) valuable at lower price. ) 2) life of option (longer life is better)
when can you use the option pricing principle models to value real options?
1) underlying asset is traded 2) an active marketplace exists for the option itself 3) the cost of exercising the option is known
Challenges to valuing private companies (4)
1) usually no SEC filing, stock price, β, σ 2) statements/projections might be optimistic 3) don't necessarily follow gaap 4) personal expenses included
obtaining inputs for option valuation
1) value of underlying asset 2) variance in value of underlying asset 3) exercise price on option 4) expiration of option 5) dividend yield
What are 7 ways PE firms can improve portfolio company operations?
1. Improve Management :There is some evidence that PE firms are willing to give management a larger share of equity upside which may allow PE firms to attract more talented management. 2. Optimizing Incentives: Some companies have poorly aligned incentives. Perhaps top management needs more equity upside to take advantage of their entrepreneurial capabilities. Perhaps the sales force needs to be compensated based on the profits rather than the revenue their accounts generate. Perhaps separate divisions need to be given reasons to cooperate rather than protect their own fiefdoms. 3. Funding and Supporting Accretive M&A: Commonly referred to as the "roll-up" strategy. There are many highly fragmented industries out there which are ripe for consolidation. Some PE companies buy one of the leading competitors which they see as a "scalable platform" and then help it to buy and integrate several smaller rivals. This strategy creates value in a couple of ways. First, truly scalable businesses realize synergies when they merge and become more profitable together. Second, larger companies with higher market share are generally seen as stronger and more stable competitors that should trade at higher multiples. For this reason, "tuck-in" acquisitions can frequently be done at multiples which are lower than that of the "platform" business, a phenomenon known as "multiple arbitrage". 4. Cut Costs: Public companies and family-owned businesses are sometimes unwilling or unable to cut costs which are economically suboptimal or outright wasteful. PE firms are generally less skittish about cutting overheads, extravagant perks, and redundancies. 5. Restructure or Turn Around Business: Some businesses require difficult long term changes to re-position them in changing markets. Such restructurings frequently require short-term pain, investment, and patience to realize long-term success. PE is uniquely positioned to support such restructurings because its investment horizon can be several years or longer and it does not have to keep up with the quarterly public markets earnings treadmill. 6. Professionalizing a small or family business: Many middle market PE firms add value simply by purchasing under managed family businesses or small companies who are looking to grow to the next stage and introducing standard business practices. We're talking about "Management 101" stuff here such as investing in IT systems, standardizing accounting practices, creating talent management systems, introducing activity-based costing, optimizing pricing, etc. The trading multiple of a business can go up by quite a bit simply by bringing the business up to professional standards. 7. Driving Synergy between Portfolio Companies: Some PE firms with large portfolios have been able to drive value by getting their portfolio companies to collaborate. For example, some of the mega funds have recently started an initiative to consolidate the massive combined purchasing power of the companies they control. In this manner they have been able to decrease the costs of some of the common goods and services their portfolios companies buy. Another example is when a PE firm buys a company which is a natural customer of or supplier to other existing portfolio companies. The PE firm can facilitate these companies coming together (where it makes economic and strategic sense of course) in order to make one or both better off.
3 factors influencing the equilibrium interest rate
1. Inflation, which is a rising trend in the prices of most goods and services -if the dollars you get back buy less stuff, you need to get more dollars 2. Risk, which leads investors to expect a higher return on their investment -if there is a chance you may not get your money back, you need more dollars to hedge your risk 3. Liquidity preference, which refers to the general tendency of investors to prefer short-term securities - if you have to tie up your money for more time, you need more dollars
order of payments
1. bondholders (debt holders) because maturity date 2. preferred stock because fixed dividends
3 sanity checks
1. did I make 3 adjustments for semiannual? (PMT, N, Rate) 2. did the price / interest relationship hold? (inverse) 3. Is the price (PV) between $700 and $1300
required return is likely to differ from the coupon interest rate because either (2 reasons)
1. economic conditions have changed, causing a shift in the basic cost of long-term funds 2. the firm's risk has changed
No load mutual funds may increase fees through
12b‑1 plans
History -capital sources (2)
1946- American research and development 1958- Small Business Investment Act & SBIC.
Later History (3)
1979 - prudent man rule of Employee Retirement Income Security Act. 1980s -High yield bond industry - encourages LBO's 1989- Michael Milken indicted on 89 charges...junk bond market dries up LBO boom dried up
Year of Repeal of Glass Steagall
1994
Year of Repeal of Reg Q regarding interest rate ceiling
1999
Walk me through the steps in an IPO?
6 - 12 months before: - Finalize preparation of historical interim and annual financial information (consider translation of financial information if filing in Quebec). - Make necessary changes to the executive board and begin recruiting additional board members. - Start building financial model and business plan. - Meet with stock exchange representatives and discuss the transaction with the relevant stock exchange. - Consider investor relations strategy and equity story. - Implement financial reporting procedures and controls. - Agree on draft timetable. 1.5 - 6 months before: -Finalize timetable. - Consider adequacy of working capital and use of proceeds. - Produce draft prospectus and other documents and ensure compliance with all reporting requirements. - Do initial review of pricing issues. - Review public relations presentations. - Begin initial marketing. - Commission expert reports, if required. - Appoint non-executive directors. - Eliminate dealbreakers and resolve any potential litigation or due diligence issues. - Prepare roadshow presentations to targeted potential investors. 0 - 1.5 months before - Begin formal marketing. - Price and allocate the offering. - File the preliminary prospectus. - Have underwriter perform marketing of securities ("book building"). - Admission to stock exchange is granted and trading commences after receipt of the final prospectus
turnover
A business's total sales revenue.
Distribution of payments
A cash flow management strategy that involves distributing payments throughout the month, year or other period so that large expenses do not occur at the same time and cash shortfalls do not occur. Distributing payments throughout the year means there is a more equal cash outflow each month rather than large outflows in particular months.
Discounts for early payment
A cash flow management strategy that involves offering creditors a discount for early payments. This strategy is most effective when targeted at those creditors who owe the largest amounts over the financial year period. This is not only beneficial for the creditors who are able to save money and therefore improve their cash flow, but it also positively affects the business's cash flow status.
Factoring (cash flow management strategy)
A cash flow management strategy that involves the selling of accounts receivable for a discounted price to a finance or specialist factoring company. The business saves on the costs involved in following up on unpaid accounts and debt collection. This strategy is growing in popularity as a strategy to improve working capital.
Income Statement
A financial statement that presents the revenues and expenses and resulting net income or net loss of a company for a specific period of time
Balance Sheet
A financial statement that reports assets, liabilities, and owner's equity on a specific date.
Comparative ratio analysis
A firm's performance is best assessed when judgements are made by comparing a firm's analysis against other figures, percentages and ratios.
debenture / corporate bond
A fixed interest loan issued by a company secured by its assets.
Define Free Cash Flow.
A measure of a company's financial health. It is calculated by subtracting capital expenditures (CapEx) from operating cash flow. In other words; FCF is how much cash a company has after accounting for all CapEx.
Define Amortization.,
A method of spreading the depreciation and cost of an intangible asset over the course of its. The best example of this is for a patent, which does not decrease in value, but appropriated a specific cost at the start and will expire after a certain period of time. If the patent cost 50,000 USD, and lasts 10 years - the annual amortization expense is equal to 5,000 USD
Absorption Costing
A method used to charge an apporopriate amounts of overheads to cost units. Uses both Variable and Fixed costs.
bankruptcy
A person, organization or business legally declared insolvent because of inability to pay debts.
redeemable preference shares
A preferred stock issued by a company with a fixed repurchases price at a specific date. Example: The company sold one preference share for $ 10 and promises the buyer to buy it back at 4th of December for $ 8 (if the share price is higher, the buyer can sell it elsewhere).
cumulative preference shares
A preferred stock which allows holders to claim for omitted dividends even after years. Example: A natural disaster led to a production loss and no dividends were paid 3 years long. After three years the company is able to pay new dividends, but before paying dividends to common shareholders, they have to pay cumulative dividends to the holders of cps.
debt factoring
A process whereby a company can 'sell off' open customer accounts (unpaid invoices) to a third part in order to bring in the money sooner.
Gearing
A ratio that focuses on the long-term financial stability and capital structure of a business. The gearing ratio measures the proportion of assets in a business that are financed by borrowing
balance sheet
A report that summarizes all of an entity's assets, liabilities, and equity as of a given point in time.
Real Assets
A tangilbe or intangible asset, owned by the firm
corporation tax
A tax on company profits.
Variance Analysis
A technique for determining the cause and degree of difference between the baseline and actual performance.
withdrawal/withdraw
A withdrawal involves removing funds from a bank account, trust, pension or savings plan.
Control of current assets
A working capital management strategy that seeks to control current assets by ensuring that current assets like cash, receivables and inventories are converted into cash on a timely basis.
Control of current liabilities
A working capital management strategy where the focus is on minimising the costs related to a firm's current liabilities. This involves being able to convert current assets into cash to ensure that the business's creditors (accounts payable, bank loans or overdrafts) are paid.
How to calculate the accounting equation
ASSETS = LIABILITIES + OWNERS' EQUITY
Well known VC Firms Large to small
Accel Partners (20B) New Enterprise Associates (13.35B) Sequoia Capital(7.6B) Andreessen Horowitz (5.85B) Khosla ventures (2.75B) SV Angel (153M)
Often are backed by lines of credit
Agency Bonds
current asset
An asset listed on the balance sheet with less than a 12-month life, or that is readily convertible into cash to be used to satisfy current liabilities. Examples of current assets are cash on hand, short-term investments, accounts receivable, and inventory.
operating expense
An expense incurred in carrying out an organization's day-to-day activities, but not directly associated with production. Operating expenses include such things as payroll, sales commissions, employee benefits and pension contributions, transportation and travel, amortization and depreciation, rent, repairs, and taxes.
overhead(s)
An indirect cost for general administration, or for light, heat etc.
WHICH INDUSTRY WOULD YOU INVEST IN AND WHY?
Another common way to ask how attractive an industry is. The trick to this question is that it's not simply about identifying a good industry, but rather is about identifying an industry which is improving. If an industry is already high-growth and profitable, the valuations of acquisition targets are also likely sky high. Investing is about buying undervalued assets rather than simply good assets. If you identify a bad/mediocre industry which is about to improve, you could probably find a lot of undervalued acquisition targets in it. Therefore, look for industries which are experiencing some of the following: • Acceleration in long-term growth: Driven by new technology, an inflection point in adoption, changing consumer preferences, etc. • A shift in competitive rivalry: E.g. competitors are beginning to compete on brand, quality, service, technology, etc. instead of price. E.g. a major competitor is exiting the industry. • A shift in supply chain dynamics: E.g. the industry is consolidating. This could lead to both add-on acquisition opportunities as well as better bargaining power relative to suppliers and customers. • Barriers to entry increasing: E.g. patents, proprietary technology, brand, minimum efficient scale, etc. are becoming more important • Threat from substitutes declining: E.g. the products and services the industry provides are becoming more unique and essential to customers.
What do you think is going to happen to LBOs/M&A/private equity in the coming months and years?
As we've discussed already, the private equity industry is going through a difficult transition period. You need to be up to speed on the state of major deals out there, financing, future growth, fund raising, the whole thing. Don't be surprised if a piece in The Wall Street Journal or The Daily Deal from that very morning is mentioned, and be prepared to respond to it. Naturally, areasonably bullish outlook for the industry is likely an asset—why else are you applying?—but don't sugarcoat it, either. Talk about the challenges facing the industry in a reasonable way, how the industry might overcome them, and why you ultimately think the industry will continue to grow and prosper.
Equity (equation)
Assets - Liabilities
Initial Outlay
At the beginning of a project (CF0) -capital expenditures -projects consist of the purchase of assets - machinery, buildings, companies -NWC outlay -an increase in sales causes an increase in Accounts Receivable, Inventory, and Accounts Payable. This is almost always a net use of cash
End-of-Life Cash Flows
At the end of a project (CFn) -Reclamation Expenditures -projects may involve the sale of assets or the incursion of expenses (plus or minus is always NET of taxes -NWC recovery -a cessation of sales causes a decrease in A/R, Inventory, & A/P. This is always a net source of cash
ARR (equation)
Average annual profit/average investment X100
Ownership of federal debt securities is documented through use of a ___________ system
Book entry
Define: - Sharpe Ratio - Sortino Ratio What's the difference? Whats a good ratio value?
Both allow you to determine if a portfolio's returns are due to smart investing, or just a higher level or risk. Sharpe Ratio - A risk adjusted measure of portfolio return, to evaluate a portfolio's performance Sharpe ratio = (Mean portfolio return − Risk-free rate)/Standard deviation of portfolio return Sharpe penalizes both upside & downside volatility Sortino - A risk adjusted measure of portfolio return, that uses only returns that fall below a minimally accepted target (bad risk) Sortion only penalizes upside volatility For both: a ratio of 1 is good, 2 is better, and 3 is amazing
Static Budget Variance
Budget - actual
cost of preferred stock (1 component)
COPS (rp) is the ratio of the preferred stock dividend to the firm's net proceeds from the sale of preferred stock 1. flotation costs Dp= dividend Np= market price - flotation cost rp = Dp / Np -preferred stock gives preferred stockholders the right to receive their stated dividends before the firm can distribute any earnings to common stockholders -dividends may be stated as a dollar amount -sometimes preferred stock dividends are stated as an annual percentage rate, which represents the percentage of the stock's par, or face, value that equals the annual dividend
What is CAPM?,
Capital Asset Pricing Model; consider the expected return on a group of assets and its relationship between systematic risk (market risk). The model states that an investor must be compensated for both risk and time value of money.
ordinary shares / common stock
Company shares that usually pay a dividend and have voting rights.
Comparative ratio analysis (against standards)
Comparing business performance against standard industry benchmarks gives financial managers of what the industry regards as best practice.
Comparative ratio analysis (over different time periods)
Comparing business performance to a business's past performance at similar times to identify trends.
Comparative ratio analysis (with similar businesses)
Comparing business performance to a similar business or against competitors' performance gives financial managers of how the business is performing in the context of the market.
Overdrafts (control of current liabilities)
Control of this current liability can be undertaken by monitoring and reviewing bank charges as charges vary depending on the type of overdraft.
Payables (control of current liabilities)
Control of this current liability is possible by trying to manipulate the timing of payments by delaying payments as late as possible to avoid having to borrow money.
The Market Value of Wealth
Current share price x Outstanding shares. Prices are established by 'the market' and published.
HOW WOULD YOU ESTIMATE ROUGHLY HOW MUCH DEBT CAPACITY IS AVAILABLE FOR AN LBO?
Debt capacity for an LBO is typically constrained by three primary ratios: - total leverage ratio; - interest coverage ratio; and - minimum equity ratio Any one of these ratios could be the governing constraint for a particular deal. To estimate debt capacity for an LBO, you could estimate debt capacity under each of those ratios and take the lowest of the three • Total Leverage Ratio: The most common method for estimating this ratio is Total Debt / LTM EBITDA. During normal times, Maximum Debt = ~5.0x(LTM EBITDA). During hot debt markets this ratio can go up to ~6.0x, and during cold debt markets it can fall to ~4.0x. This ratio can also be higher or lower based on the nature of the target's business. Highly cyclical or risky businesses with few tangible assets are on the lower end of the range, while stable business with a lot of tangible assets (which can be liquidated to repay debt holders in the event of default) are on the higher end of the range. • Interest Coverage Ratio: The most common method for estimating this ratio is LTM EBIT / Annual Interest Expense. The floor for this ratio is usually around 1.5x. Therefore, the maximum debt this ratio will allow is roughly: = LTM EBIT / (1.5 * BlendedInterestRate) The blended interest rate depends on prevailing interest rates and how the overall LBO debt package is structured, but roughly 8-9% is a safe assumption. • Minimum Equity Ratio: Long gone are the days when PE firms could routinely buy targets for 5-10% Equity and 90-95% debt as a percentage of the total acquisition price. These days lenders demand that about 20-30% of the total acquisition price be equity. As such, you could estimate: Maximum Debt = 0.75 (Total Acquisition Price)
WHAT ARE SOME DIFFERENT TYPES OF DEBT COVENANTS AND WHAT ARE THEY USED FOR?
Debt covenants are contractual agreements between lenders and borrowers (such as companies which have been bought via an LBO) that give lenders certain rights to help protect their investment. Maintenance covenants require the borrower to maintain a certain equity cushion or debt service coverage cushion to maintain their ability to repay its debt. Incurrence covenants prevent the borrower from taking certain actions which could be detrimental to existing lenders such as taking on more debt or paying out cash dividends to equity holders. Strict covenants can make an investment much riskier to a PE investor because a default on a covenant can result in the loss of the entire equity investment even if the portfolio company remains solvent. See the section on covenants for details.
Financial Manager
Decided what investements the firm should make and how they should be paid for.
IN WHAT WAY IS DEFERRED REVENUE DIFFERENT FROM ACCOUNTS RECEIVABLE?
Deferred revenue is a liability because the company has already collected money from customers for goods or services it has not yet fully delivered. Accounts receivable is an asset because the company has delivered goods or services for customers and has not yet been paid.
(to) deposit
Definition: A transaction involving a transfer of funds to another party (bank, etc. ) for safekeeping. Example: Usually people deposit their money in bank accounts.
loan capital
Definition: Capital received by borrowing from a bank or other financial institution. Example: UniCredit lends $ 40.000 to the sole proprietor Baker paid back until two years.
reserves
Definition: Funds or material set aside or saved for future use. Example: VW needs to have a high amount of reserves because of the Dieselgate
crowd sourcing/funding
Definition: The amount and value of products or material a company has available for sale or use at the beginning (opening stock) or at the end (closing stock) of an accounting period. Example: This year's opening stock was last year's closing stock.
pre-paid expenses
Definition: The amount and value of products or material a company has available for sale or use at the beginning (opening stock) or at the end (closing stock) of an accounting period. Example: This year's opening stock was last year's closing stock.
share capital
Definition: The amount and value of products or material a company has available for sale or use at the beginning (opening stock) or at the end (closing stock) of an accounting period. Example: This year's opening stock was last year's closing stock.
stock (inventory)
Definition: The amount and value of products or material a company has available for sale or use at the beginning (opening stock) or at the end (closing stock) of an accounting period. Example: This year's opening stock was last year's closing stock.
revenue reserves
Definition: The portion of a business' profits retained by the company for investment in future growth, and are not redistributed to the shareholders through regular or special dividends. Example: P&G retained 70% of their profit in the company, to have enough money for R&D.
external liabilities
Definition: The total amount of debts owed to external investors (no shareholders), e.g., banks. Example: After delivery, the company signed a note payable, which is an external liability, to the supplier.
Statement of Retained Earnings
Details the movement in owners equity over a period of time. Includes ; Net profit/loss, share capital, dividends and changes in accounting policy
Paypack Period
Determins how quickly the beenfits will repay tha inital investment.
NPV
Difference between the present value of cash inflows and present values of cash outflows.
Production Costs
Direct labour + direct materials + overheads
Set by 12 Fed banks
Discount rate
Policy tools of Fed (3)
Discount rate, open market operations, required reserves
The most independent central bank in the world is ____
ECB
Expected Values
EV= Outcome X Probability
Differences between Debt and Equity: Voice in Management
Equity -stockholders are owners of the firm -stockholders have voting rights that permit them to express an opinion about the firm's directors and occasionally vote on very special issues, such as new share issuance Debt -debtholders do not have general voting rights in the firm -debtholders rely on the firm's contractual obligations in the bond covenants to be their voice
Venture Capital
Equity Investments in less mature nonpublic companies to fund the launch, early development, or expansion of business
non-operating expense
Expense incurred in performance of activities not directly related to the main business of a company, such as for insurance or maintenance of the assets.
accrued expenses
Expense that is not yet paid and noted as a payable.
Free Cash Flow: what does it determine in Private Equity? What does FCF actually do and how does each stakeholder get paid out?
FCF is the lifeblood on an LBO because FCF determines how much debt a company can service which then determines how much leverage an LBO can use. The conceptual explanation of FCF is that it is the total amount of cash profits that a company can pay out to its owners, be they equity holders or debt holders. Equity holders are generally paid with dividends, whereas debt holders generally get interest payments. The fastest way to calc FCF = EBIT * (1 - Tax Rate) + D&A - CapEx - Change in NWC
Sets Fed monetary Policy
FOMC
WHAT CONSTITUTES A GOOD LBO TARGET?
FUk
An open market sale leads to an expansion of reserves and deposits in teh banking system and hence to a decline in the monetary base and the money supply
False
Central Banks typically use long term rates as their policy instrument
False
Federal Reserve monetary policy decisions must be approved by the Secretary of the Treausry before they may be implemented
False
Most of the time, the interest rate on Treausyr notes is below that on money market securities because of their low default risk
False
The current yield on a bond is a good approximation of the bond's yield to maturity when the bond matures in five years or less and its price differs from its par value by a large amount
False
National Bank requirement
Fed Member
Financial management objectives
Financial management has the short-term goals of ensuring that a business is sufficiently liquid and solvent, while also aiming to boost long-term profitability, growth and efficiency.
Global financial management
Financial management strategies needed to manage the the concerns associated with the growth of global business.
Exchange rates (global financial management)
Fluctuations in these rates create risks for global business. Depreciation and appreciations will impact on both import and export levels and the payments made to overseas businesses or financial intermediaries.
What is IRR formula for a single return cash-flow? What is the MoM formula?
For example, let's say a PE firm invested $1 million in a deal and realized a return of $3 million after five years. Its IRR would be (3/1) ^ (1/5)-1 = 24.6% MoM is very easy to calculate = (Sum of all Net Returns) / (Cash invested)
How to calculate NET PROFIT
GROSS PROFIT - EXPENSES
Gross profit ratio
GROSS PROFIT ÷ SALES
HOW DO YOU GAUGE INDUSTRY GROWTH RATES
Gauging growth rate • Estimate the industry's historical growth rate from industry reports or from the aggregate revenue growth rates of participant companies. • Discover the primary drivers of historical growth (e.g. technology improvement, untapped market penetration, growing product/service adoption, price growth, etc.) from industry reports, participant's public disclosures, or calls with industry experts. • Discover how growth drivers are trending and project future growth from educated assumptions about the main drivers.
HOW DO YOU GAUGE INDUSTRY PROFITABILITY
Gauging profitability Discover the historical profit margins of industry participants and then utilize the 5-forces framework to gauge whether industry-wide profit margins are likely to shrink, grow, or remain steady. The 5-forces framework is as follows: 1 • Bargaining power of suppliers: The relative level of consolidation between industry participants and the industry's suppliers frequently determines which side is likely to capture most of the profits. If industry participants are more consolidated than the industry's suppliers that is a good sign for future profitability. If not, the reverse may be true. 2 • Bargaining power of customer: Similar logic applies as Suppliers' Bargaining power. If industry participants are more consolidated than their customers it's a good sign for profitability. 3 • Threat from new entrants: How strong are the industry's Barriers to Entry (BTEs)? Strong BTEs include essential/exclusive intellectual property, high fixed capital investment requirements, high minimum efficient scale thresholds, and high value placed on brand and existing relationships. Highly profitable industries with low BTEs are likely to lose profitability over time as new competitors pile in. 4 • Threat from substitute products: A good signal is when the industry's products or services meet essential customer needs which cannot be met other different ways. 5 • Existing competitive rivalry: It's a good sign if the existing competitors have established a pattern of competing on factors other than price and on focusing on growing the industry rather than taking market share from each other.
No asset or revenue pledge
General Obligation Bond
total sales
Gesamtumsatz
WHAT ARE SOME COMMON WAYS PE FIRMS INCREASE PORTFOLIO COMPANY VALUE?
How much value PE firms actually add is an open question, but the following methods are frequently mentioned: • Recruit better management and board members • Provide more aligned management incentives (usually via stock option pool) • Identify and finance new organic growth opportunities (new geographies, new product lines, adjacent market verticals, etc.) • Find, finance, and execute add-on acquisitions • Foster stronger relationships with key customers, suppliers, and Wall Street • Support investment in better IT systems, financial reporting and control, research & development, etc.
IF I GAVE YOU $X, HOW WOULD YOU INVEST IT?
I usually answer this question by following these steps: • Discuss a few of the investment options available to you • State what your investment goal, risk appetite, and time horizon is • Compare and contrast the risks, rewards, and time horizons of these options • Pick the investment options which best fits these criteria The investments options with which I am most familiar are private equity co-investment, bonds, and equities, so I would limit my investments to those areas because I would not invest in something I do not understand well. I have a long way to go before retirement, so my main investment goal is a high rate of return. However, I would also like to purchase a home in about five years, so I will require liquidity around that time. In order to meet my goals, I would invest 10% of my assets in PE co-invest because historically it offers the highest long-run return. I would not invest more than 10% because co-invest is highly illiquid and too correlated with the fortunes of my employer. I would invest 60% of my assets in passive equities funds, split evenly between domestic and international stocks to take advantage of equity's historically solid returns while increasing diversification. I would then invest the final 30% of my assets in a low-cost medium-maturity bond fund because such bonds are relatively uncorrelated with equity investments and ensure I will be able to buy a home in five years.
Why does an LBO work? Walk me through the steps
In an LBO, a PE firm acquires a company using a combination of Debt and Equity, operates it for several years, and then sells it; the math works because leverage amplifies returns; the PE firm earns a higher return if the deal does well because it uses less of its own money upfront. Assumptions for PDIR Sources & Uses Adjust the BS Financial Projections / Levered CF / Debt Schedule Exit assumptions Step 1: Make assumptions for the Purchase Price, Debt and Equity, Interest Rate on Debt, and Revenue Growth and Margins. Step 2: Create a Sources & Uses schedule to calculate the Investor Equity paid by the PE firm. Step 3: Adjust the Balance Sheet for the effects of the deal, such as the new Debt, Equity, and Goodwill. Step 4: You project the company's statements, or at least its cash flow, and determine how much Debt it repays each year. Step 5: You make assumptions about the exit, usually using an EBITDA multiple, and calculate the MoM multiple and IRR.
You buy a $100 EBITDA business for a 10x multiple, and you believe that you can sell it again in 5 years for 10x EBITDA. You use 5x Debt / EBITDA to fund the deal, and the company repays 50% of that Debt over 5 years, generating no extra Cash. How much EBITDA growth do you need to realize a 20% IRR?
Initial Investor Equity = $100 * 10 * 50% = $500 20% IRR Over 5 Years = ~2.5x multiple (2x = ~15% and 3x = ~25%) Exit Equity Proceeds = $500 * 2.5 = $1,250 Remaining Debt = $250, so Exit Enterprise Value = $1,500 Required EBITDA = $150, since $1,500 / 10 = $150
A PE firm acquires a $100 million EBITDA company for a 10x multiple using 60% Debt. The company's EBITDA grows to $150 million by Year 5, but the exit multiple drops to 9x. The company repays $250 million of Debt and generates no extra Cash. What's the IRR?
Initial Investor Equity = $100 million * 10 * 40% = $400 million Exit Enterprise Value = $150 million * 9 = $1,350 million Debt Remaining Upon Exit = $600 million - $250 million = $350 million Exit Equity Proceeds = $1,350 million - $350 million = $1 billion IRR: 2.5x multiple over 5 years; 2x = 15% and 3x = 25%, so it's ~20%.
real rates are the same; if nominal rates go up with no inflation then real rates will also go up
Interest rate parity
Responsibility of the Central Bank (3)
Interest rate, Extending Credit, Monetary policy/money supply
Operating Risk
Is the risk associated with the mix of VC and FC. Indicated the sensitivity of operating earnings to change in unit sales
Captial Employeed
Is the sum of shareholders Equity and debt liabilities. Total Assets - Current Liabilities
Risk
Is the variability of possible returns. -several possible outcomes -Enough past experiences to predict the outcome: = probability x impacf
The Principle Budget Factor
Is what drives the whole Budget. e.g Sales or volune
Equity
Is what the business owes to its owners. It represents the amount of capital that remains in the business after its assets are used to pay off outstanding liabilities
Why is interest expense not subtracted when calculating project cash flow?
It is already accounted for in the discount rate (WACC)
Financial Management
Managing the organisations finances. Concerned with investments, financing and distribution decisions.
Marginal Costing
Marginal costing is a costing method which charges products with variable costs alone. The fixed costs are treated as period costs and are written off in total against the contribution of the period.
Growth Equity
Mature Businesses that do not need early stage VC nor would a buyout of PE firm make sense for growth
Net profit ratio
NET PROFIT ÷ SALES
Return on equity ratio
NET PROFIT ÷ TOTAL EQUITY
why is NPV a better methodology for capital budget assessments than the payback method?
NPV accounts for time value of money
Conducts open market operations
NY Fed
What are the three largest Federal Reserve Banks in terms of assets
NY, Chicago, San Francisco
Return on Equity
Net Income / Shareholders Equity
Return on Assets
Net Income / Total Assets
EPS
Net Income available to ordinary shareholders / No. of ordinary shares outstanding
net income before/after tax
Net income (before tax) is a company's total earnings (or profit); net income is calculated by taking revenues and subtracting the costs of doing business such as depreciation, interest and other expenses. Net income after tax is net income minus taxes.
Net Profit Margin
Net profit / total revenue X100
How to calculate COGS
OPENING STOCK + PURCHASES - CLOSING STOCK
Profit Conscious
Object is for managers to maximising the extent to which the organisations achieves its long-term objective.
Budget Constrained
Objective is for managers to ensure that a budget is achieved.
Cost of Sales
Opening stock + production costs - closing stock
Cash Cycle
Operating Profit - Payables Payments Period
profit before/after tax
PBT (also called EBT) is the sum of all revenues (operating, financing etc.) reduced by the totaled amount of all expenses except tax expenses. EBT after taxes is equal to total earnings.
American research and development
PE investment firm that raised capital from sources other than wealthy families had broader social goals → increase standard of living for American people
early 200s valuation rules
PEIGG fair value (entrance price)= amount at which an investment could be exchanges in a current transaction between willing parties, other than in a forced liquidation sale
Cash outflows (examples)
Payments to suppliers (raw materials/finished goods), interest on loans, operating expenses (wages/salaries, raw materials/finished goods), drawings, purchase of assets and loan repayments.
creditor / accounts payable
Person or organisation to whom money is owed (for goods or services supplied , or as repayment for a loan.
Assets under management: Priv Capital, PE, Hedge Funds
Private Capital: 4.4 Trillion Private Equity: 2.5 Trillion (1.5 U.S) Hedge Funds: 3.2 Trillion
Mangement Accounting
Produces Reports for a company's internal shareholders as opposed to external. Managers uses it to make ST decisions.
undistributed profit
Profit which has not (yet) been distributed as dividends to shareholders. Example: The shareholders are very mad, because the company didn't distribute their profits as dividends.
retained profits
Profits generated by a company that are not distributed to stockholders (shareholders) as dividends but are either reinvested in the business or kept as a reserve for specific objectives (such as to pay off a debt or purchase a capital asset).
Leverage Ratio
Proportion of the firms liabilities that is financed by debt claims. A company that uses more equity than debt has a low leverage ratio
Working capital
Refers to the funds available for the short-term financial commitments of a business.
Cash flow
Refers to the movement of cash in and out of a business over a period of time.
Interdependence
Refers to the mutual dependence that the key functions have on one another. They key functions work best when they overlap and employees work towards common goals. Each function area depends on the support of the others if it is to perform at capacity.
instalments
Regular (usually monthly) part payments of debts.
Treasury securities
Repurchase
Liquidity problem
Reserve Requirement
The monetary liabilities of th Fed are _________ and _______
Reserves, Currency in Circulation
Financial resources
Resources in a business that have a monetary or money value.
Gross Profit
Revenue - Cost of Sales
Operating Profit
Revenue - Cost of sales - general admin expenses
Profit
Revenue - cost of sales- non manufacturing costs
Assets Turnover(equation)
Revenue / Total Assets
Recurring Cash Flows
Revenues -less CoGS -less Op ex -less depreciation - revenue * MACRS % Equals Pre-tax profit -less taxes Equals after-tax profit - plus depreciation Equals Cash flow
The ________ mortgage allows retired people to live off equity in their homes without having to sell it
Reverse Annuity
Owner's Capital
Share Capital + Reserves
preference shares / preferred stock
Shares, often with no voting rights, which receive their dividend before all other shares and are repaid first at face value if the company goes into liquidation.
Cost Volume Analysis
Shows how costs and revenues change in response to volume.
What does a balance sheet show?,
Shows the assets, liabilities, and shareholders' equity of the business. It must be balanced because assets must equal liabilities + shareholders' equity. The statement starts with cash and equivalents (cash and liquid investments), accounts receivable, inventory, and property as assets are accounted for, before finally subtracting the firm's liabilities. Net income from the Income Statement changes to retained earnings as dividends are subtracted. The balance sheet provides a financial snapshot of the company at a particular time.
What does an income statement show?,
Shows the performance of the business; beginning with sales (revenue), then deducting the cost of goods sold (total cost necessary to sell the product or service). Deducting COGS from Sales gives us the Gross Profit (profit before operating expenses). At the end of the statement is the Net Income. The income statement assesses profitability over a given period of time.
Define Deprectiation.,
Similar to amortization, however is used for tangible assets. It is calculated with a straight-line method or an accelerated method. Unlike assets that fall under amortization, assets that depreciate have residual salvage value which must be subtracted from its cost to determine the amount which can be depreciated. E.G: Company cars resold at the end of their cycle.
Strengths and weakness of NPV method
Strengths -accounts for time value of money -considers actual cash flows Weaknesses -hard to find a comparable company that is public beta -lots of value in terminal value -WAAC assumes constant cap structure
Cost of Equity - What is CAPM - CAPM Formula - What are each components of the CAPM formula and what are their typical %? - Beta, what does = 1, 0<1, and >1 mean for a stock? - Common examples of low and high beta companies?
The Capital Asset Pricing Model (CAPM) is a model which describes the relationship between the riskiness of assets and the rate of return investors should expect in order to willingly bear those risks. While CAPM is a foundational theory in finance, because it isn't used much in PE aside from using it to estimate the cost of equity, we won't dive into the details. Just remember the following equation: Cost of Equity = RiskFreeRate + Beta * EquityRiskPremium RFR = Usually equal to the yield on safe government bonds (2-4% is a safe assumption in developed markets like the US Equity Risk Premium = The premium return over the Risk Free Rate investors demand in order to take the risk of investing in a diversified "Market Portfolio" of equities. Typically 5-6% in developed markets like the US. Beta = A measure of how levered a particular stock's returns are to the diversified Market Portfolio of equities. Beta of exactly 1 signifies the stock is exactly as risky as the diversified Market Portfolio. A Beta between 0 and 1 signifies the stock is somewhat less risky than the Market Portfolio. A Beta above 1 signifies the stock is more risky than the Market Portfolio. Common low Betas are utilities and consumer staples companies because such companies produce essential goods consumers need regardless of whether the economy is doing well. Common high Betas include semiconductors and durable assets (like cars) because demand for them soars when the economy is doing well but plummets during recessions.
The Liquidation Value of Wealth
The amount of cash that would remian if all assets were sold now and used to pay off Liabilities.
Where are the next opportunities for private equity?
The answer to this depends on the position, of course. If you're interested in fund raising, talk about new potential sources of funds, including any ideas floating around about public offerings and the like, or potential new sources of private placements. If you're in deal-making or operations, be ready to discuss the trends you've read about recently, such as emerging market LBOs or a particular domestic sector. New financing plans are always welcome, too.
HOW MIGHT YOU STILL CLOSE A DEAL IF YOU AND THE SELLER DISAGREE ON THE PRICE OF THE ASSET DUE TO DIFFERENT PROJECTIONS OF ITS FUTURE OPERATING PERFORMANCE?
The classic PE solution to this common problem is called an "Earn-out". Sellers are frequently more optimistic about the future performance of a business than PE investors are willing to underwrite. In such cases either party may propose that the sellers are paid a portion of the total acquisition price up-front, while a portion is held back (frequently in an escrow account) until the business' actual future performance is determined. If the business performs like the seller expects then the seller is paid the remainder of the purchase price some months or years after the close of the deal. If the business under-performs the seller's expectations then the buyer keeps some or all of the Earn-out money. This type of structure is a common way of bridging valuation gaps between buyers and sellers.
HOW WOULD YOU CALCULATE CHANGE IN NET WORKING CAPITAL (NWC)?
The classic formula for NWC is current assets (excluding cash) less current liabilities. For a lot of businesses, it is sufficient to define NWC as: NWC = Accounts Receivable + Inventory-Accounts Payable. Change in NWC is simply the difference between NWC in the current period less NWC during the previous period.
production costs
The costs related to making or acquiring goods and services that directly generates revenue for a company.
WHAT MIGHT CAUSE TWO COMPANIES WITH IDENTICAL FINANCIAL STATEMENTS TO BE VALUED DIFFERENTLY?
The financial statements do a good job of describing a company's historical performance, but they do not necessarily tell us everything we need to know about a company's future performance. Since the value of a company depends primarily on its expected future performance, the financial statements are insufficient. Some important things financial statements don't tell us include, but are not limited to: • The future growth of the company's industry • The company's competitive position including share, relationships, patents, etc. • The reputation and capabilities of the company's management team • The quality of the company's future strategy
equity / owners capital
The net amount of funds invested in a business by its owners, plus any retained earnings. It is also calculated as the difference between the total of all recorded assets and liabilities on an entity's balance sheet.
capital reserves
The portion of business profits by capital retained and added to equity.
Financial Accounting
The preparation of financial information in forms of reports.
depreciation
The process of spreading the value of an asset over its useful life.
amortisation
The process of spreading the value of an intangible asset (intellectual property: patents, trademarks, copyrights, etc.) over its useful life.
return on investment (ROI)
The profit from an activity for a particular period compared with the amount invested in it.
Why will a project with a positive NPV (if it turns out, in fact, to be positive) accomplish a financial manager's corporate objective?
The project will increase shareholder wealth
WHY DOES PE GENERATE HIGHER RETURNS THAN PUBLIC MARKETS?
The short answer is that PE LPs demand higher returns than public market investors which causes PE investors to price their deals to an IRR of 20% or higher. PE LPs demand these high returns for two main reasons: • LBOs are highly levered thus making PE investments riskier than public stocks. • PE investments are much less liquid than public stocks; it can take up to ten years to realize returns.
WHY DOES PE USE LEVERAGE? OR HOW DOES LEVERAGE INCREASE PE RETURNS?
The short answer is that PE returns are calculated based on return on their invested equity. Using leverage to do deals allows you to use less equity which means the ultimate returns are larger in comparison to the amount of equity initially invested. Another way to look at it is that the cost of leverage (debt) is lower than the cost of equity because equity is priced to an IRR of 20%+, whereas the annual interest expense on debt is usually below 10%. Yet another way to look at it is using a lot of debt makes the return on equity much more volatile and much riskier because the debt must be repaid before the equity gets any return. The high returns on PE equity may be seen as the fair return associated with the extra risk associated with high leverage.
IF YOU HAD TO VALUE A COMPANY BASED ON A SINGLE NUMBER FROM ITS FINANCIAL STATEMENTS, WHAT WOULD THAT NUMBER BE?
The single most important value determinant for most companies is its Free Cash Flow (FCF) because FCF is how owners pay themselves dividends and pay down debt. If you could know a second fact about the company before estimating its value you would want to know how quickly its FCF is growing.
HOW WOULD YOU DETERMINE AN APPROPRIATE EXIT MULTIPLE ON A PE DEAL?
There are a few common way to do this. See the sections Comparable Multiples, Precedent Transactions, and LBO Model. Comparable multiples analysis will tell you what multiples similar public companies are trading for on the stock market. Precedent transactions will tell you what the multiples were on deals involving similar targets. An LBO analysis (in this case referred to as a Next Financial Buyer analysis) will tell you what multiple a financial sponsor would be willing to pay in the future.
WHICH VALUATION TECHNIQUES USUALLY PRODUCE THE HIGHEST VS. LOWEST VALUES? WHY?
There is a great deal of variability among the outcomes of different valuation techniques for different industries and companies. Some banker interview guides state that there is a commonly accepted order of valuations with precedent transactions at the top and market valuation at the bottom. However, the reality is that it is difficult to predict which techniques will yield higher or lower valuations. The most I would say is as follows: • The cost of PE equity is higher than nearly any other form of capital, so in an efficient market, PE backed LBO valuations should tend to be on the lower side on average. Of course there are times when this is not the case, especially when a company is under-levered or poorly managed. • Precedent transactions tend to be on the higher side, especially when the buyer is "strategic" because such buyers frequently pay both a control premium and a synergy premium. • Public comps / market valuations tend to be roughly in the middle of the pack depending on whether the market is hot or cold. • DCF analyses are also middle of the pack on average, but there is a wild variability in DCF analyses on both the high side and the low side because DCF analyses are extremely sensitive to input assumptions.
Liabilities
These appear on the balance sheet and are claims by people other than owners against the assets (items of debt), and represent what is owed by the business. Current liabilities must be repaid within 12 months, whereas non-current liabilities must be met some time after the next 12 months.
Non-current liabilities
These appear on the balance sheet and are claims by people other than owners against the assets (items of debt), and represent what is owed by the business. These debt obligations must be met some time after the next 12 months. For example, debentures, unsecured notes and mortgages.
Current liabilities
These appear on the balance sheet and are claims by people other than owners against the assets (items of debt), and represent what is owed by the business. They must be repaid within 12 months. They usually include overdraft and accounts payable.
Non-current assets
These appear on the balance sheet and are items of value owned by the business that are not expected to be turned into cash within 12 months. For example, machinery, vehicles and fixtures.
Assets
These appear on the balance sheet and are items of value owned by the business. Current assets can be turned into cash within 12 months, whereas non-current assets are not expected to be turned into cash within 12 months.
Loans
These are borrowings from banks and other financial institutions and the business must make interest payments and repayments regularly.
Project budgets
These are budgets that relate to capital expenditure and research and development.
Financial budgets
These are budgets that relate to financial data of a business and include the budgeted income statement, balance sheet and cash flows.
Operating budgets
These are budgets that relate to the main activities of a business and may include budgets relating to sales, production, raw materials, direct labour, expenses and cost of goods sold.
Fixed costs (cost controls)
These are costs that are not dependent on the level of operating activity in a business. Fixed costs do not change when the level of activity changes — they must be paid regardless of what happens in the business. Examples of fixed costs are salaries, depreciation, insurance and lease.
Variable costs (cost controls)
These are costs that change proportionately with the level of operating activity in a business. For example, materials and labour.
Finance expenses
These are costs/expenses associated with borrowing money from outside the business and to minimise risk (eg interest on debt and insurance payments).
Administrative expenses
These are costs/expenses that relate to the general running of the business (eg stationery).
Derivatives
These are simple financial instruments that may be used to lessen the exporting risks associated with currency fluctuations.
Debt finance
These are sources of finance that relate to the short-term and long-term borrowing from external sources by a business.
Indirect costs
These are those costs that are shared by more than one product.
Direct costs
These are those costs that can be allocated to a particular product. Direct costs are also called variable costs.
Unit trusts
These financial institutions are also known as mutual funds and are funds that fund managers run on behalf of investors for a fee. Fund managers use the money that investors have contributed and make these funds available for business financing with the aim of growing the original amount within the unit trust for their investors.
Life insurance companies
These financial institutions are also non-bank financial intermediaries who provide cover and a lump sum payment in the event of death. Policy holders pay regular premiums and the insurer guarantees to pay the designated beneficiary a sum of money upon death of the insured person. Life insurance companies provide both equity and loans to the corporate sector through the insurance premiums they receive, which provide funds for investment.
Finance companies
These financial institutions are non-bank financial intermediaries that specialise in smaller commercial finance. They provide mainly short-term and medium-term loans to businesses through consumer hire-purchase loans, personal loans and secured loans. They are also the major providers of lease finance to businesses. Some finance companies specialise in factoring or cash flow financing.
Superannuation funds
These financial institutions provide funds to the corporate sector through investment of funds received from superannuation contributions. Superannuation funds are able to invest in long-term securities as company shares, government and company debt because of the long-term nature of their funds.
Investment banks
These financial institutions provide services in both borrowing and lending, primarily to the business sector. They provide a wide variety of different types of loans for businesses and can therefore customise loans to suit the business's specific needs.
Financial institutions
These institutions perform a range of financial services for businesses, especially giving loans. Examples include, banks, investment banks and superannuation funds.
Owners' equity
This appears on the balance sheet and is the funds contributed by the owner(s) and represents the net worth of the business. It is calculated by subtracting total liabilities from total assets. Includes retained earnings and the money the owners initially put into the business (capital).
Cost of goods sold (COGS)
This appears on the income statement and is a term that refers to all the costs to the business directly associated with goods that have been sold to customers. This includes costs such as purchase and production costs.
Gross profit
This appears on the income statement and is a term that refers to that part of a business's profit that represents operating income (mainly from sales) minus cost of goods sold.
Net profit
This appears on the income statement and is a term that refers to the difference between the gross profit and expenses.
Sales
This appears on the income statement and is a term that refers to the total amount of money from selling products to customers over a period of time in the form of cash sales or credit sales.
Ordinary shares
This external source of equity finance is most commonly traded in Australia. Investors (individuals) pay funds in return for a share of ownership in a publicly listed company. This means they get voting rights according to the number of shares that they have and uncertain rewards in the form of dividends.
Profitability management
This financial management strategy involves controlling both the business's costs and its revenue.
Cash flow management
This financial management strategy is undertaken to improve financial performance and involves making sure that the business has sufficient cash to meet obligations at any point in time.
Working capital (liquidity) management
This financial management strategy is undertaken to improve the financial performance of the business and is concerned with monitoring and controlling how cash flows within the business with the aim to avoid cash flow shortages or excess surpluses. It involves determining the best mix of current assets and current liabilities needed to achieve the objectives of the business.
Profitability
This financial objective is the ability of a business to maximise its profits. It is determined by the level of revenues less total costs. Increasing profitability involves either increasing revenues and/or reducing costs.
Efficiency
This financial objective is the ability of a business to minimise its costs and manage its assets so that maximum profit is achieved with the lowest possible level of assets.
Growth
This financial objective is the ability of the business to increase its size in the longer term and depends on its ability to develop and use its asset structure to increase sales, profits and market share. It can expand by acquiring more resources, merging with another business and acquiring another business.
Liquidity
This financial objective is the extent to which a business can meet its financial commitments in the short-term (less than 12 months). A business must have sufficient cash flow to meet its financial obligations or be able to convert current assets into cash quickly; for example, by selling inventory, to finance current liabilities.
Solvency
This financial objective is the extent to which the business can meet its financial commitments in the longer term (more than 12 months). Solvency is particularly important to the owners, shareholders and creditors of a business because it is an indication of the risks to their investment.
Global economic outlook (global market influences)
This global market influence refers specifically to the projected changes to the level of economic growth throughout the world and how this affects the revenues of Australian businesses that trade goods internationally.
Interest rates (global market influences)
This global market influence refers to the cost of borrowing money and how global market forces can affect domestic interest rates, impacting on the ability of firms to borrow.
Tell me what you did in your last position that helped your company find value?
This goes to the very core of what it means to work for a private equity firm.You should be able to walk into an interview with four to five solid examples of how your actions directly saved your previous employers money. This could be from developing operational efficiencies to ferreting out information that helped save money on an M&A deal. Maybe your research helped a company develop a new product line, or your ideas spurred cost savings on benefits. Whatever it is, be prepared to talk frankly and in detail about how you are an agent of value creation.
Australian Securities and Investment Commission (ASIC)
This independent government body regulates and monitors activities by companies to ensure that corporate laws like the Corporations Act 2011 are followed.
Global market influences
This influence refers to how business decisions are not affected by domestic factors, but also by the events in global financial markets.
Influence of government
This influences financial management as it regulates what companies can and can't do and imposes penalties for non compliance. The primary regulatory bodies are the Australian Securities and Investment Commission (ASIC) and the Australian Taxation Office (ATO) because of company taxation.
HOW WOULD A $100 DECREASE IN DEPRECIATION EXPENSE ON THE INCOME STATEMENT IMPACT ALL THREE MAJOR FINANCIAL STATEMENTS?
This is a common interview question in both banking and PE and comes in many forms (e.g. what happens when A/R increases, Inventory decreases, tax rate increases, capex decreases, etc.) so you need to familiarize yourself with how the financial statements connect in the Financial Statement Connections section. Income Statement • When depreciation decreases by $100, EBIT and EBT increase by $100. •When EBT increases by $100m, net income increases by ~$60 (assuming a ~40% corporate tax rate which means an extra $40 is paid in taxes). Balance Sheet • Since net income increased by $60, shareholder equity also increases by $60. • Since an extra $40 is paid in cash taxes, cash decreases by $40. • Since depreciation decreased by $100, net PP&E increases by $100. • The balance sheet remains in balance since liabilities went up by $60 and assets went up by $60. Cash Flow Statement • Net income increased by $60 which increases cash from operations, but PP&E increased by $100 which decreases cash from operations. • The net impact is that cash from operations declines by $40 which happens to match both the only cash expense incurred by the drop in depreciation (taxes) as well as the drop in cash on the balance sheet.
Expense minimisation (cost controls)
This is a cost control measure that involves the process of reducing financial, administrative and selling costs in an effort to boost profitability.
Prospectus
This is a document accompanying an IPO that contains relevant details about the company so that investors can make informed decisions.
Australian Securities Exchange (ASX)
This is a financial institution that is the primary stock exchange group in Australia where shares are bought and sold by investors.
Cash flow statement
This is a financial statement that indicates the movement of cash receipts and cash payments resulting from transactions over a period of time. A cash flow statement is usually prepared from the income statement and balance sheet, as these summarise the transactions of the business. Only cash transactions are included in the cash flow statement.
Income statement
This is a financial statement that is a summary of the income earned and the expenses incurred over a period of trading. It helps users of information see exactly how much money has come into the business as revenue, how much has gone out as expenditure and how much has been derived as profit.
Balance sheet
This is a financial statement that represents a business's financial position at a particular point in time. It shows assets, liabilities and owners' equity and indicates what the business owns, what it owes and how its assets are financed.
Option contract
This is a form of derivative used by exporters that gives the buyer (option holder) the right, but not the obligation, to buy or sell foreign currency at some time in the future.
Forward exchange contract
This is a form of derivative used by exporters that is a contract to exchange one currency for another currency at an agreed exchange rate on a future date, usually after a period of 30, 90 or 180 days.
Swap contract
This is a form of derivative used by exporters that is an agreement to exchange currency in the spot market with an agreement to reverse the transaction in the future.
Commercial bills
This is a form of short term borrowing that are primarily short-term loans issued by financial institutions, for larger amounts (usually over $100 000) for a period of generally between 30 to 180 days.
Overdraft
This is a form of short term borrowing where the bank allows a business or individual to overdraw their account up to an agreed limit and for a specified time, to help overcome a temporary cash shortfall.
Leasing
This is a long-term source of borrowing for businesses. It involves the payment of money for the use of equipment (such as machinery) that is owned by another party. It is a form of financing because the business does not have to outlay the entire sum initially.
Financial needs (planning and implementing)
This is a part of planning and implementing that involves identifying the financial actions that need to be taken place to achieve specific outcomes. These are determined by the overall business plan.
Financial controls (planning and implementing)
This is a part of planning and implementing where policies and procedures are implemented to ensure that the plans of a business will be achieved in the most efficient way.
Budgets (planning and implementing)
This is a part of planning and implementing where the business forecasts the expected costs and revenues of business activities over a set of time. Financial outcomes of business activities, such as credit and debt levels and cash flow are considered.
Record systems (planning and implementing)
This is a part of planning and implementing whereby mechanisms are employed by a business to ensure that data are recorded and the information provided by record systems is accurate, reliable, efficient and accessible. The data is used for the production of cash flow statements, income statements and balance sheets.
Planning and implementing
This is a process of financial management where the business must plan and implement a clear system of financial management whereby outflows of money (costs) are matched by inflows (revenues) to avoid problems in the short and long term.
Revenue controls - marketing objectives
This is a profitability management strategy that is about controlling revenue through the marketing function to improve profitability. Marketing strategies and objectives should lead to an increase in sales and hence an increase in revenue.
Factoring (source of finance)
This is a short-term source of borrowing for a business that enables a business to raise funds immediately by selling accounts receivable at a discount to a firm that specialises in collecting accounts receivable. This is an important source of short-term finance because the business will receive up to 90 per cent of the amount of receivables within 48 hours of submitting its invoices to the company that has bought the accounts receivables.
Internal sources of finance
This is a source of finance that comes from within the business itself and do not require the business to turn to outside individuals or institutions. It can come from either the business's owners (equity or capital) or from the outcomes of business activities (retained profits).
Company taxation
This is a tax payable by all Australian businesses that have been incorporated — that is, all private and public companies. This tax affects profitability because it is a flat rate of 30 per cent of net profit. Company tax is paid before profits are distributed to shareholders as dividends.
Unsecured note
This is a type of long term debt finance from individuals or institutions investors for a set period of time. Unsecured notes are not secured against the business's assets and therefore present the most risk to the investors in the note (the lender) and for this reason the business pays a higher interest rate.
Debentures
This is a type of long term debt finance from investors that is issued by a company for a fixed rate of interest and for a fixed period of time. Interest is paid whether or not the business is making a profit.
What's been the most disappointing thing you've experienced in your career so far?
This is a very nice way of asking if you've learned from your mistakes. Nobody's going to get it right all the time, and they're going to want to know how you deal with adversity. Now, if your actions directly resulted in torpedoing a billion-dollar M&A deal ... perhaps you may not want to mention that! But be prepared to talk about a project or deal that didn't go as planned. Don't blame others too much, either. Take responsibility for your part and explain how you've changed your approach since. Come off as having learned something from the experience.
Equity
This is an external source of funds that refers to the finance raised by a company through inviting new owners.
What are you most proud of in your career to date?
This is another opportunity to talk about things you've done to help create value. It can be an investment you identified or a trend you spotted, or any of the things mentioned above. But make it a good one, and make it relevant to the private equity firm's goals.
Secondary market (ASX)
This is another securities market for a business managed by the ASX in their role as a financial institution, where it enables the sale of pre-owned or second-hand shares that are traded between investors who may be individuals, businesses, governments or financial institutions.
Primary market (ASX)
This is important securities market for a business managed by the ASX in their role as a financial institution, where it enables a company to raise new capital through the issue of shares and through the receipt of proceeds from the sale of securities.
WALK ME THROUGH ONE OF THE DEALS ON YOUR RESUME
This is one of the most common questions in a PE interview if you come from a deal-oriented background. The interviewer might let you choose a deal to discuss or pick one at random from your CV. The interviewer might ask you anything from a simple high level overview all the way down to a detailed discussion of the investment thesis, purchase price, operating forecast, and expected returns. This type of question is used to gauge the following: •• Your investment judgment •• Your knowledge of the PE investment process •• Your ability to focus on the most important issues •• Your knowledge of PE financing, accounting, and modeling •• Your deal memory for deal facts and context •• Before you walk into any PE interview, you should reacquaint yourself with the following facts about every deal on your CV: •• Purchase price, including the multiples of EBITDA and EBIT it represented •• Sources and uses of capital •• The investment thesis and its primary drivers •• The key diligence issues and findings •• The base operating case/projection •• Key risks and upsides •• Projected returns (IRR & MoM) •• Key members of the management team ••What your role was and what value you added to the team ••Whether you personally thought it was a good deal and why
Gearing
This is related to the financial objective of solvency and is the proportion of debt (external finance) and the proportion of equity (internal finance) that is used to finance the activities of a business. Gearing ratios determine the firm's solvency.
Receivables
This is sums of money due to a business from customers to whom it has supplied goods or services. They are recorded as accounts receivable.
Inventories
This is the amount of raw materials, work-in-progress and finished goods that a business has on hand at any particular point in time.
Monitoring and controlling
This is the financial management process of measuring and comparing the actual performance of the business with against planned performance and taking corrective action as needed.
Retained profits (retained earnings)
This is the most common source of internal finance and are the funds that come from the profits of the business that are not distributed, but are kept in the business as a cheap and accessible source of finance for future activities.
Influences on financial management
This is the part of the syllabus that focuses on the decisions that financial management must make that are affected by a range of different factors, including the nature and availability of different sources of finance, government decisions, and global market conditions.
Accounting equation
This is the what forms the basis of the accounting process, shows the relationship between assets, liabilities and owners' equity.
Initial Public Offering (IPO)
This is when a company issues shares to the public for the first time and is required to issue a prospectus.
Capitalising expenses (limitation of financial reports)
This limitation to financial reports refers to an accounting method where a business records an expense as an asset on the balance sheet rather than as an expense on the income statement. This does not accurately represent the true financial condition of the business as it understates the expenses and overstates the profits as well as the assets of the business. Examples of capitalising expenses include research and development.
Timing issues (limitation of financial reports)
This limitation to financial reports refers to how businesses can exploit timing issues in financial statements to give a misleading impression of the financial position of the business. For example, when an accountant records revenue, they should also record at the same time any expenses that were directly related to that revenue.
Debt repayments (limitation of financial reports)
This limitation to financial reports refers to how the issue of debt repayments can limit the usefulness of financial reports as it may not be clear when the repayments have to be made or how long has had or has been recovering debt.
Notes to the financial statements (limitation of financial reports)
This limitation to financial reports refers to the notes that are attached to the financial statements to help readers better understand the financial report. Information in these notes can be subjective and therefore potentially misleading.
Bill of exchange (method of international payment)
This method of international payment is a document drawn up by the exporter demanding payment from the importer at a specified time.
Letter of credit (method of international payment)
This method of international payment is a document that a buyer can request from their bank that guarantees the payment of goods will be transferred to the seller. The letter of credit is issued by the importer's bank to the exporter promising to pay them a specified amount once certain conditions have been met.
Clean payment (method of international payment)
This method of international payment occurs when the exporter ships the goods directly to the importer before payment is received.
Limitation of financial reports
This process of financial management refers to the need to be cautious when analysing financial reports because they may not give a completely accurate assessment of a business's financial position.
Ethical issues related to financial reports
This process of financial management refers to the ways in which businesses make decisions about methods used to compile financial reports, for example, how a business values it's assets and the extent to which the business complies with the legal aspects of financial regulations.
WHAT ARE SOME COMMON AREAS OF DUE DILIGENCE?
This question may be asked broadly as above, or it may be asked specifically about a particular deal (e.g. what would you most want to diligence before buying company X?) • See the section Common Diligence Topics. If the question is asked broadly, you can describe the high level categories (commercial, valuation, accounting, and legal) and give a few examples from each category. If the question is asked about a specific company, you will need to use your best judgment to decide which issues from the common diligence topics section (in addition to any personal experience you have) are most relevant.
WALK ME THROUGH AN LBO MODEL AT A HIGH LEVEL
This question may come as a stand-alone question, as part of a case question, or as part of a question about one of your past deals. At a high level, there are 5 steps to an LBO: • Calculate the total acquisition price, including acquisition of the target's equity, repayment of any outstanding debt, and any transaction fees (such as the fees paid to investment banks and deal lawyers, accountants, consultants, etc.). • Determine how that total price will be paid including: equity from the PE sponsor, roll-over equity from existing owners or managers, debt, seller financing, etc. • Project the target's operating performance over ~5 years and determine how much of the debt principal used to acquire the target can be paid down using the target's FCF over that time. • Project how much the target could be sold for after ~5 years in light of its projected operating performance; Subtract any remaining net debt from this total to determine projected returns for equity holders. • Calculate the projected IRR and MoM return on equity based on the amount of equity originally used to acquire the target and the projected equity returns upon exit
Dividends
This refers to a distribution of a company's profits (either yearly or half-yearly) to shareholders and is calculated as a number of cents per share. They do not have to be paid if the business is not making any money and the business decides on the amount that is paid. This does not have to legally be repaid.
Rights issues (ordinary shares)
This refers to a source of equity finance to raise funds after the IPO. Existing shareholders are offered the opportunity to purchase more shares in the company at a special price.
Placements
This refers to a source of equity finance where additional shares are offered at a discount to their current trading price to special institutions or investors. This discount is intended to persuade specific investors to invest in the company.
Share purchase plan
This refers to a source of equity finance where businesses give existing shareholders the opportunity to buy new shares at a reduced cost, for example without brokerage fees.
Audit
This refers to an independent check of the accuracy of financial records and accounting procedures.
Expenses
This refers to costs of the business and are incurred in the process of acquiring or manufacturing a good or service to sell and the costs (direct and indirect) associated with managing all aspects of the sales of that good or service.
Business purpose
This refers to the activity or reason for which a business needs to acquire finance.
Investing activities (cash flow statement)
This refers to the cash inflows and outflows relating to purchase and sale of non-current assets and investments. These assets and investments are used to generate income for the business. Examples include the selling of an old motor vehicle, purchasing new plant and equipment or purchasing property.
Financing activities (cash flow statement)
This refers to the cash inflows and outflows relating to the borrowing activities of the business. Borrowing inflows can relate to equity (issue of shares or capital contribution from owner) or debt (loans from financial institutions). Cash outflows relate to the repayments of debt and cash drawings of the owner or payments of dividends to shareholders.
Operating activities (cash flow statement)
This refers to the cash inflows and outflows relating to the main activity of the business — that is, the provision of goods and services. Income from sales (cash and credit) make up the main operating inflow plus dividends and interest received. Outflows consist of payments to suppliers, employees and other operating expenses (insurance, rent, advertising, etc.).
Debt finance (long term borrowing)
This refers to the external sources of finance a business has borrowed for periods longer than 12 months. It can be secured or unsecured, and interest rates are usually variable. It is used to finance real estate, plant (factory/office) and equipment. Types includes mortgages and debentures.
Debt finance (short term borrowing)
This refers to the external sources of finance that a business is expected to repay within one year. It is provided by financial institutions through overdrafts, commercial bills and bank loans. This type of borrowing is used to finance temporary shortages in cash flow or finance for working capital.
Terms of finance
This refers to the legally binding conditions that determine the basis on which the business obtains finance (such as a loan agreement).
Financial management
This refers to the planning and monitoring of a business's financial resources to enable the business to achieve its financial objectives.
Matching principle
This refers to the principle that when a business identifies and plans to meet its financial objectives, it is necessary to match the terms of finance with its business purpose. This means that short-term finance should be used to purchase short-term assets and long-term finance should be used for long-term assets.
Leasing (working capital management strategy)
This working capital management strategy involves purchasing the rights to use an asset (eg machinery) by making periodic payments, for a period of time, rather than purchasing it outright.
Sale and lease back (working capital management strategy)
This working capital management strategy involves the selling of an owned asset to a lessor and leasing the asset back through fixed payments for a specified number of years.
Over 10 years in maturity
Treasury Bond
Financial Accounting
Treats money as a means of measuring econoic perormance. Involves past information and is required by law. Is for external users mainly.
Chartering a bank is a bank regulation that helps reduce the adverse selection problem
True
Companies can issue callable bonds if they want to alter the capital structure
True
Limiting deposit insurance would help reduce the moral hazard of bank risk taking
True
Open market purchases by the Fed increase the supply of nonborrowed reserves
True
T/F rising rates, which result in decreasing bond values, are of greatest concern
True
The Board of Governors sets reserve requirements
True
The unusual structure of the Federal Reserve system is best explained by Americans' fear of centralized power
True
When the Federal Reserve System was created, its most important role was as a lender of last resort
True
rebate
Type of sales promotion whereby a customer can be reimbursed some money because they have bought a large amount of something.
WHAT IS AN ACQUISITION / CONTROL PREMIUM AND WHY IS IT PAID?
When a PE buyer (or any investor) acquires a majority share of a publicly traded company, it nearly always pays more per share than the company was trading at prior to acquisition. The percentage by which the acquisition price per share exceeds the pre-acquisition trading price per share is called a control premium (aka acquisition premium). The trading price per share prior to acquisition is commonly calculated as a 30 to 90-day trailing Volume Weighted Average Price (VWAP) prior to the day news of the pending acquisition becomed public. For example, if the 30-day VWAP of a stock is $20 on the day an acquisition is announced for $25 per share, then the acquisition premium is $25/$20-1 = 25%. The size of control premiums varies, but they are usually between 10% and 50%. There are several reasons why investors might be willing to pay acquisition premiums: • Some buyers, especially strategic buyers, expect to realize synergies with the acquired asset which makes the asset more valuable to the acquirer than to previous shareholders. • Majority control of a company allows the new owners to choose how to spend the company's capital, including how and when to take dividends or exit the investment. Unlike public shareholders, PE owners have a great deal of influence over how and when they will get cash out of their investment. • Buyers of public assets frequently believe that the company will be worth more under their control than its public valuation. They believe they can add value by getting better management, setting a better strategic direction, fixing operating problems, etc. Majority control is what gives buyers the power to execute such plans. Another way to look at control premiums is from the perspective of the sellers. A public stock has a very fragmented ownership base. Thousands or more individuals or entities may be owners of a single stock, and the top ten largest owners frequently own less than 50% of outstanding shares. In order to consummate an LBO, the buyer has to convince at least a majority of shareholders to approve the transaction. Many of these owners own the stock precisely because they think it is undervalued by the market. Such owners would not be willing to sell the stock at its market price. There are of course zero (or nearly zero) owners who would sell the stock below its trading price. Therefore, by virtue of pure math, a new buyer will need to pay more than the trading price to acquire a majority of shares.
liquidation
When company is insolvent, its operations are brought to an end and its assets are divided up among creditors an shareholders.
WHAT COMPANY WOULD BE A GOOD LBO CANDIDATE TODAY AND WHY?
You always want to have one or two good pitches in your back pocket in case you get asked this question. 1. Has a lot of stable and predictable free cash flow to pay down debt relative to how much you would have to pay to acquire it. A free cash flow yield (FCF / purchase price) of 10+% is a solid benchmark 2. Could benefit from a strategic overhaul which would be difficult to execute as a public company 3. Is having significant operational difficulties which would require a lot of time, patience, and capital to address 4. Has a bad management team or governance structure which a PE firm could improve 5. Has a lot of room to grow either organically or via acquisition if backed with enough patient long-term capital
If you wanted to evaluate an investment opportunity for PE and can only ask for three things, what would you ask for and why? No details are provided about the company (not what it does, not what industry it's in, so on)
You have to understand what they're trying to determine with this question. If they're trying to determine if you understand private equity investing, how/why it works and how to analyze an investment. Industry is important, but obvious. - 5 year Revenue CAGR(%) - LTM EBITDA($) - Cash conversion(%). From there you can ball park an IRR in about 5 minutes in Excel. While you need to know about the management team and industry outlook etc... for this type of quick "should we spend any time on this" type analysis, you're not going to dig into the industry and management team. You're not going to build out a big elaborate model and make all these assumptions based on the industry you're given. the problem interviewers get into is they get intimidated by these sort of questions and tend to give very broad and general answers, which doesn't work for a "should I invest in this company"-type question. You need to get specific in your answer as to what data you would need, so that you get specific answers from the interview. From there you have to be able to say YES I would invest or NO i would not. If you get your 3 asks... can you give him an investment answer? Lets take a shot at it... If you asked for something like FCF, Cap structure and management experience. - Company will generate $450 million over the next 5 years - the industry is healthcare/pharma (they manufacture pharmaceuticals for race horses) - the CEO has 25 years of experience in pharmaceutical manufacturing, he has an undergrad degree in biochem and an MBA, CFO has 20 year experience at a big pharma company, COO similar background Should you invest in this company? Almost all members of an executive teams will each have 15-30 years experience, some sort of higher education degree etc... they'll all be "impressive" on paper. If you had asked for 5 yr revenue CAGR, LTM EBITDA and cash conversion you'd have gotten the following to work with: - 5 yr rev cagr is 5% - LTM EBITDA is $70 million - Cash conversion is 50% (unlevered) ---- You should be able to get an idea of how big of a deal this is based on EBITDA x purchase multiple (informed by CAGR) ---- can ball park FCF generation over the next 5 years by applying cash conversion % to EBITDA and growth that FCF by CAGR each year ---- slap a boilerplate cap stucture on it, come up with an IRR and you know if its in the realm of do-able or not If its showing a 11% IRR do I give to shits if the CEO and CFO are the smartest guys in the world? Do I care which industry they are in? I would ask for those 3 things and explain how I would use them to ball park an IRR. Then I can gauge if I should spend more time on this or not. If the IRR is in an attractive range I'd want to dig in more. Understand the business model, the industry outlook, where comps are trading at, any potential fatal flaws (i.e. material litigation, environmental liability issues, etc...). The only reason you care about revenue is because it drives your EBITDA, if you can get to EBITDA you don't care about revenue. The only reason you care about EBITDA is because it drives FCF and because it drives valuation. Capital structure is meaningless. You want to keep your answers as simple as possible, why would you voluntarily propose some convoluted share structure? You want assumptions to be as simple as possible, you purchase the company outright, no breakage costs, etc...
Rolling Budget
a budget that is continuously updated/Periodically adjusted and ammended so that the next 12 months of operation are always budgeted.
Casino banking/finance,
a colloquial term used to describe an investment approach in which investors at commercial banks employ risky financial strategies to earn large rewards.
Dividend reinvestment plans offer which advantages?
a convenient means to accumulate shares, dollar cost averaging
Owners of bonds would prefer
a debt ratio of 40 percent to a debt ratio of 60 percent a times‑interest‑earned of 5.1 to a times-interest-earned of 3.9
corporate bond
a debt security issued by a corporation and sold to investors, an interest is offered to this
Preferred stock generally pays
a fixed dividend
Bonds,
a government, or company can raise capital by issuing a bond. Bondholders receive interest (a 'coupon') and the capital is repaid at maturity. The difference between bonds and loans is that bonds can be traded between investors (who are lending to the issuer).
yield curve
a graphic depiction of the term structure of interest rates
An exit fee has the same impact of
a load fee of the same percentage
corporate bond
a long-term debt instrument indicating that a corporation has borrowed a certain amount of money and promises to repay it in the future under clearly defined terms
trustee
a paid individual, corporation, or commercial bank trust department that acts as the third party to a bond indenture and can take specified actions on behalf of the bondholders if the terms of the indenture are violated
Hard market,
a scarcity of a product or service for purchase, as opposed to a soft market, in which the product or service is readily available.
for bonds with a longer maturity,
a small change in interest rates will lead to a substantial change in the bond's value
NPV (net present value)
a sophisticated capital budgeting technique; found by subtracting a project's initial investment from the present value of its cash inflows discounted at a rate equal to the firm's cost of capital NPV = present value of cash inflows - initial investment if the NPV is GREATER than $0, ACCEPT the project if the NPV is LESS than $0, reject the project if the NPV is GREATER than $0, the firm will earn a return GREATER than its cost of capital. Such action should increase the market value of the firm, and therefore the wealth of its owners by an amount equal to the NPV a robust valuation method value-creation measurement correct mathematics rank projects
Index funds tend to track
a specific measure of the market
Liquidity,
ability of an asset to be traded quickly without changing the market price.
Coverage ratios measure a firm's
ability to meet fixed payments such as interest
Which of the following is a cash outflow?
acquiring inventory
cost of common stock: new equity
aka cost of a new issue of common stock is the cost of common stock, net of underpricing and associated flotation costs new shares are underpriced if the stock is sold at a price below its current market price, P0 rn = new equity or new issued common stock D1= dividend Nn = net proceeds from sale of common stock (sale of common stock - underpricing&flotation) -will be less than the current market price - therefore, the cost of new issues will always be greater than the cost of existing issues, rs, which is equal to the cost of retained earnings - the cost of new common stock is normally greater than any other long-term financing cost g = growth rate rn = D1/Nn + g
overdraft
an extension of credit from a lending institution when an account reaches zero (bank allows customers to borrow a set amount of money).
Principal,
an investor who trades for his/her own account and risk.
Asset,
an item with economic value that is owned or controlled by an individual, business or government.
Rates of return reported by mutual funds
are based on change in net asset value and the fund's distributions
Exchange traded funds
are bought and sold in secondary markets
Cash dividends
are paid from earnings reduce the firm's assets
mutually exclusive projects
are projects that compete with one another, so that the acceptance of one eliminates from further consideration all other projects that serve a similar function implies they are in a capital rationing situation and will use a ranking approach to determine which project to invest in
independent projects
are projects whose cash flows are unrelated to (or independent of) one another; the acceptance of one does not eliminate the others from further consideration implies they are in an unlimited funds situation and that they will used a accept-reject approach to determine what projects to invest in
issued shares
are shares of common stock that have been put into circulation issued shares = outstanding shares + treasury stock
constant growth valuation (Gordon model)
assumes that the value of a share of stocks equals the present value of all future dividends (assumed to grow at a constant rate) that it is expected to provide over an infinite time horizon P0 = D1 / rs - g does not look at risk; it uses market price, P0, as a reflection of the expected risk- returned preference of investors in the marketplace can easily be adjusted for flotation costs to find the cost of new common stock theoretically equivalent to CAPM
exclusivity test for expansion project
barriers may range from strong (exclusive gov. licenses to weaker (brand name, knowledge to weakest (first mover)
Why is depreciation added back to after-tax profits when calculating cash flow?
because it was never a cash expense
MACRS depreciation is subtracted _________ taxes, then added back
before -MACRS is the fastest depreciation the IRS will allow -faster depreciation reduces profits, reducing taxes, increasing csh flow -MACRS is a double-declining balance with a mid-year convention but just use the tables
conversion feature
benefits bondholders allowing them to change each bond into a stated number of shares of common stock if feature benefits the holder, it makes the bond more valuable
to copy a call...
buy stock and borrow
Friends and Family finance are ________ and are _______ sources of capital. usually only get a _______ return.
cheap and are large sources of capital. usually only get a 0% return. aka just get their money back.
Maximin
choose the alternative with the best of the worst possible payoffs. 'Least worst outcome'
Portfolio,
collection of securities held by an investor. Also known as a 'fund'.
Money market mutual funds invest in
commercial paper repurchase agreements
Equity
consists of funds provided by the firm's owners (investors or stockholders) that are repaid subject to the firm's performance
Futures,
contract between two parties to trade a commodity or security at a fixed price and a fixed future date.
Which of the following is not a short‑term, liquid asset?
corporate stock
COGS
cost of goods sold
Period Cost
costs that are taken directly to the income statement as expenses in the period in which they are incurred or accrued
bonds: PMT
coupon payment annual PMT = coupon rate * FV divide by 2 for semi-annual PMTS
Margin of Saftey (equation)
current output- breakeven output
bonds
debt issued by: companies (finance projects or general financing), federal government (finance deficit spending), state and local government (finance schools, roads, prisons, etc) -fixed promise-to-pay -first position for cash flows in case of liquidiaton -lower relative risk to the bondholder, therefore lower relative rate of return, since they are safer most bonds pay interest semiannually at a stated coupon interest rate, have an initial maturity of 10 to 30 years, and have a par value of $1,000 that must be repaid at maturity
Distressed Debt
debt of companies with an impending or actual covenant default. sometimes controlling position is built.
stockholder return < expected return
decrease in share price
capital asset pricing model (CAPM)
describes the relationship between the required return, rs, and the nondiversifiable risk of the firm as measured by the beta coefficient rs = Rf + b * (rm -Rf) Rf = risk free rate of return rm = market return; return on the market portfolio of assets differs from the constant-growth valuation in that it directly considers the firm's risk, as reflected by beta, in determining the required return or cost of common stock equity does not provide simple adjustment mechanism to flotation costs because it does not include market price, P0, a variable needed to make the adjustment theoretically equivalent to constant growth valuation
Mutual funds __________ realized capital gains and income
distribute
inflation premium
driven by investors' expectations about inflation the MORE inflation they expect, the HIGHER will be the inflation premium and the HIGHER will be the nominal interest rate
EBITDA
earnings before interest and taxes depreciation and amortisation
risk free rate
embodies the real rate of interest (R*) plus the expected inflation premium (IP)
Early History: buyouts
end of 19th century - wealthy families began to invest in businesses 1901- J pierpont Morgan acquisition of carnegie steel company for 480M was first true buyout
nominal rate of interest for a security is
equal to the risk-free rate (consisting of the real rate of interest plus the inflation expectation premium) plus the risk premium
strategic options
even though a project may have negative NPV, it maybe worth taking if the option provides firm to take other projects in the future, providing a compensating value. firms use this rationale to take negative NPV or negative return projects
The portfolios of international funds
exclude U. S. securities
as imports increase, currency _______
falls
as price levels rise, currency _____
falls
T/F interest expense is included in a project cash flow forecast
false : not included in project cash flow forecast. The cash flows will ultimately be discounted by the WACC, which includes cost of debt
T/F the longer amount of time until a bond's maturity, the less responsive is its market value to a given change in the required return
false: the shorter amount of time
interest rate on overnight loans from one bank to another
federal funds rate
Small Business Investment Act & SBIC
federally guaranteed risk-capital pools and put private sector in charge. (could borrow half capital from gov. and got good tax breaks however rigid regulations, fraud +waste. led to developed private equity investors
Empirical studies of returns earned by investment companies indicate that
few funds outperform the market consistently
Mid Stage
financial analysis starts to matter. company is producing and shipping and may or may not be profitable. Capital used for expansion, marketing, development. VC's switch from a support tole to a more strategic role
review and analysis
financial managers perform formal review and analysis to asses the merits of investment proposals
Comparables
find similar companies: risk, growth rate, capital structure, size and timing of cash flows. quick to use, but difficult to find value and performance information for other private companies
public offering
firm offers its shares for sale to the general public
decision making
firms typically delegate capital expenditure decision making on the basis of dollar limits
fee
fixed amount or a percentage paid to an agent/professional for performing particular services.
implementation
following approval, expenditures are made and projects implemented. Expenditures for a large project often occur in phases
Which of the following is a reason for selecting a mutual fund?
high tax efficiency
how did Michael Miliken Encourage growth of LBO industry
high yield junk bonds enabled risky firms to borrow money even when banks would not lend them money
The net asset value of a mutual fund increases with
higher stock prices
Debt
includes all borrowing incurred by a firm, including bonds, and is repaid according to a fixed schedule of payments
Credit default swap,
insurance-like contract that transfers credit risk. The buyer of the swap makes payments to the seller in exchange for protection in the event of a default. Banks and other institutions have used credit default swaps to cover the risk of mortgage holders defaulting.
Operating income is not affected by
interest earned
Broker,
intermediary between a buyer and a seller, receiving commission on the trade.
Debt capital markets (DCM),
investment bank division responsible for issuance and pricing of debt securities (eg bonds).
Equity capital markets (ECM),
investment bank division responsible for structuring and pricing the issuance of equities, such as at IPO (Initial Public Offering - flotation of the company on the stock exchange).
corporate venture capital
investment of corporate funds directly in external startup companies. 30.3B invested in 2016. 13% of venture deals involve CVC but these deals represented 44% of the value of venture deals.
Bull,
investor who buys believing prices will rise.
Bear,
investor who sells believing prices will fall.
direct debit
is a financial transaction in which one person withdraws funds from another person's bank account.
cost of capital
is a weighted average of the cost of funds which reflects the interrelationship of financing decisions
constant-growth model (Gordon model)
is a widely cited dividend valuation approach that assumes that dividends will grow at a constant rate, but a rate that is less than the required return P0 = D1/ rs - g
operating expenditure
is an outlay of funds by the firm resulting in benefits received within 1 year
capital expenditure
is an outlay of funds by the firm that is expected to produce benefits over a period of time GREATER than 1 year
After a buyout, control of the company ______________________
is concentrated in the hands of LBO management and no public stock outstanding
A hedge fund
is open to a select number of individual investors
unlimited funds
is the financial situation in which a firm is able to accept all independent projects that provide an acceptable return implies that projects are independent and will use the accept-reject to determine what projects to invest in
capital budgeting
is the process of evaluating and selecting long-term investments that are consistent with a firm's goal of maximizing shareholder wealth
The return on equity
is the ratio of net income to equity
yield
is the total amount of profit, a company earns through a former investment.
VC method pros and cons
large discount rates should take care of risk, value of their time etc. separately in the analysis
best player in market in quality/delivery sets the price
law of one price
3 theoretical benchmarks to establish exchange rate
law of one price, purchase power parity, interest rate parity
Interest rates,
lenders demand interest on loans. The rate is dependent on future inflation expectations, as well as the 'real interest rate' - the rental cost of money. Borrowers might pay extra on top in order to compensate lenders for the credit risk.
Advantages of the corporate form of business include
limited liability for stockholders
1980s valuation rules
lower cost of market, but when iRR became the norm valuation became more important
downward sloping yield curve reflects
lower expected future rates of interest
Pre‑emptive rights permit stockholders to
maintain the proportionate share of ownership
Risk management,
management of the pure risks to which a company might be subject. It involves analysing all possible risks and determining how to handle this exposure through trading out, or transferring the risk with derivatives.
Exchange-traded funds
mimic an index of securities
As the debt ratio increases
more assets are debt financed the ratio of debt to equity increases
the low-coupon bond will have
much more volatility (changing rapidly and unpredictably) with respect to changes in the discount rate because lower coupon bonds are proportionately more dependent on the face amount to be received at maturity
2013 normal yield curve (upward sloping)
no change is expected in inflation. The requirement for a higher rate to compensate for tying up cash for a longer term shows through -rely on cheaper, short-term financing -short term interest rates are lower than long-term interest rate
which of the following is an advantage for a firm to issue common stock over long-term debt?
no maturity date on which the par-value of the issue must be repaid
Direct Lending
non-bank lenders providing capital to small and medium sized companies in the form of a loan rather than equity
bonds with a shorter maturity will
not be as sensitive to interest rate changes
share capital
number of shares x nominal (par) value (=market capitalisation)
par value
or face value, is the amount borrowed by the company and the amount owed to the bond holder on the maturity date (always 1,000)
Equity,
otherwise referred to as shares. Shareholders own a percentage of the company, and have a share in profits, as well as control via voting rights.
exclusivity test for patents
patents restrict competitors from developing similar products, but do not restrict competitors from developing other products to treat the same disease
1981 inverted yield curve (downward sloping)
people expected rates to decline in the future because they expected inflation to decline -indicated that short-term interest rates were above long-term interest rates at the time -managers should rely on cheaper more long-term financing -infrequently occur and sign of weakening economy
Which of the following is a consideration when selecting a mutual fund?
portfolio turnover 12b-1 fees unrealized losses in the fund's portfolio
NPV
present values of cash flows and terminal value ( CF(1+g)/(r-g) )
Private equity vs. private capital
private equity is under the private capital umbrella. private capital entails a lot of different things such as PE, Private debt, Fund of funds, indusrty specific firms.
capital budgeting process (5 steps)
proposal generation review and analysis decision making implementation follow-up
proposal generation
proposals for new investment projects are made at all levels within a business organization and are reviewed by finance personnel
covenants
provisions contained by bonds that are designed to protect the bondholders' interests most common restrictive covenants do the following 1. require a minimum level of liquidity, to ensure against loan default 2. prohibit the sale of accounts receivable to generate cash(selling receivables could cause a long-run cash shortage if proceeds were used to meet current obligations) 3. impose fixed-assets restrictions. The borrower must maintain a specified level of fixed assets to guarantee its ability to repay the bonds 4. Constrain subsequent borrowing. Additional long-term debt may be prohibited, or additional borrowing may be subordinated to the original loan. Subordination means that subsequent creditors agree to wait until all claims of senior debt are satisfied 5. limit the firm's annual cash dividend payments to a specified percentage or amount
YTM is also expressed as
required rate of return
follow-up
results are monitored and actual costs and benefits are compared with those that were expected. Action may be required if actual outcomes differ from projected ones
cost of common stock
return required on the stock by investors in the marketplace 2 forms of common stock financing 1. retained earnings 2. new issues of common stock
Stockholders generally have which of the following
right to share in the firm's earnings right to sell the stock
Hedge funds follow investment strategies such as
shorting "overvalued" stocks while buying "undervalued" stocks
If mutual funds make investments in efficient financial markets, they
should not outperform the market consistently
Since closed-end investment companies acquire securities in efficient financial markets, they
should not outperform the market consistently
Investment trust,
similar to unit trusts - collective investment but with a different structure. Investment trusts' value fluctuates with demand for shares on the stockmarket. The price of an investment trust does not necessarily equal the price of its underlying assets.
dividend
sort of interest paid to the shareholders in relation to their amount of shares
Stag,
speculator who buys shares at issue to sell them as soon as they trade on the market. Also called flippers.
coupon rate is also expressed as
stated rate of interest
Many exchange-traded funds limit their portfolios to
stocks included in an aggregate measure of stock prices
Hedge,
strategy offsetting the possibility of loss by holding two contrary positions in different financial instruments.
nominal rate of interest
the actual rate of interest charged by the supplier of funds and paid by the demander -differs from real rate of interest, r*, as a result of 2 factors 1. inflationary expectations reflected in an inflation premium (IP) 2. issuer and issue characteristics such as default risks and contractual provisions as reflected in a risk premium (RP)
payback method
the amount of time required for a firm to recover its initial investment in a project, as calculated from cash inflows the length of the maximum acceptable period is determined by management -if the payback period is LESS than the maximum acceptable pay back period, ACCEPT the project - if the payback period is GREATER than the maximum acceptable payback period, REJECT the period simple internal go / no-go signal no value measurement
when YTM > coupon then
the bond trades at a discount
when YTM < coupon then
the bond trades at a premium
Swap rates,
the borrowing rates between financial institutions.
Investment management,
the buying and selling of securities (see securities) and assets (see asset) within a portfolio to achieve investment objectives.
interest rate risk
the chance that interest rates will change and thereby change the required return and bond value
The current ratio is unaffected by
the collection of an account receivable
(bond) maturity
the date on which the life of a transaction ends. On that date is either has to be renewed or it will cease to exist. Example: They had to establish a new loan because the old one reached its maturity.
internal rate of return
the discount rate that equates the present value of the cash inflows with the initial investment
prudent man rule
the extension of permission to the trustee (pension funds) to allocate funds/ delegate investment management functions (5%-10%) such delegation was expressly forbidden by the former trust law.
Which of the following is not a consideration for investing in real estate investment trusts (REITs)?
the federal tax rate paid by the trust
before-tax cost of debt
the financing associated with new funds through long-term borrowing -typically the funds are raised through the sale of corporate bonds -rate of return the firm must pay on new borrowing net proceeds: are the funds actually received by the firm from the sale of a security -Np = (bond price - flotation) *if flotation cost given as % then Np = bond price - (FC%*1000) flotation costs: are the total costs of issuing and selling a security. The include 2 components 1. underwriting costs- compensation earned by investment bankers for selling the security 2. administrative costs - issuer expenses such as legal, accounting, and printing
Inventory turnover may increase if
the firm lowers the prices of its goods
private placement
the firm sells new securities directly to an investor or a group of investors
Dividend policy depends on
the firm's earnings investment opportunities available to the firm
Which of the following has no impact on cash flow?
the firm's equity
Which of the following occurs when a 10 percent stock dividend is paid?
the firm's retained earnings decrease
Derivatives,
the group term for financial contracts between buyers and sellers of commodities or securities. Includes futures, options or swaps. Derivatives allow profit from the rise (or fall) of a commodity or security, without actually buying the underlying good.
FTSE 100/250 index,
the index of the 100/250 largest companies on the UK stock market.
after-tax cost of debt
the interest payments paid to bondholders are tax deductible for the firm, so the interest expense on debt reduces the firm's taxable income, and therefore, the firm's tax liability -pretty much saying that this is the cost of debt because firms have to pay tax on bonds ri = rd * (1-T) T = government issued tax rate -typically, the cost of long-term debt for a given firm is less than the cost of preferred or common stock, partly because of the tax deductibility or interest
Money market,
the market for short-term funding such as certificates of deposit and treasury bills. Money market securities typically have a maturity of less than one year.
Brokerage,
the payment from the client to the broker.
Nice decade,
the period of non-inflationary constant expansion that followed the Government's move to give the Bank of England the freedom to set interest rates independently, soon after the Labour landslide in 1997. In May 2008 Mervyn King, the governor of the Bank of England at the time, warned, 'For the time being at least, the Nice decade is behind us.'
BreakEven
the point at which the costs of producing a product equal the revenue made from selling the product
Stock dividends cause
the price of a share of stock to fall
Which of the following occurs when a stock is split two‑for‑one?
the price of the stock decreases
If an investor's excess return is negative
the required return exceeded the realized return
Private Investments in public equity (PIPEs)
the sale of publicly listed securities to accredited investors, usually institutions. -generally for distressed companies with no other options -pipe dollars mostly go to R&D
cost of retained earnings
the same as the cost of an equivalent fully subscribed issue of additional common stock, which is equal to the cost of common stock equity rr = rs
The procedure for the distribution of dividends does not include
the settlement date
Days sales outstanding (average collection period or receivables turnover) measures
the speed with which accounts receivable are collected
how have the spreads or AAA and B corporate bonds changed over time? what impact does this have on PE activity?
the spreads vary dramatically. spread is little during good economic times and very large during bad economic times. the spreads affect cost of debt which affects buyout activity. the cheaper debt is, more it is used in leveraged PE transactions
Yield,
the total return on a security expressed as a proportion of its price.
Secondary market,
the trading of securities. The 'primary market' means the launching (issuing) of bonds and equities for the first time.
Unit trust,
the trust issues units which represent holdings of the underlying shares. The fund is divided into units which investors trade with the fund management group.
basic common stock valuation equation
the value of a share of common stock is equal to the present value of all future cash flows (dividends) that it is expected to provide P0 = D1/ (1+rs)^1 P0 = value of common stock Dt = per-share dividend expected at the end of year t Rs= required return on common stock
Which of the following should not have default risk?
treasury bills
Securitisation,
turning something into a security, for example, combining the debt from a number of mortgages to create a financial product that can be traded. Banks owning securities that include mortgage debt receive income when homeowners make mortgage payments.
options test for expansion projects: underlying asset & contingency
underlying asset = expansion project contingency = if PV of CF of expansion > expansion cost, otherwise 0
options test patents: underlying asset + contingency
underlying asset: product that would be generated by the patent contingency: if PV cash flows from development > cost of development
going public
when a firm wishes to sell its stock in the primary market, it has 3 alternatives 1. a public offering 2. a rights offering 3. private placement
Short selling,
when investors borrow an asset, such as shares, from another investor and then sell it in the relevant market hoping the price will fall. The aim is to buy back the asset at a lower price and return it to its owner, pocketing the difference.
WHAT IS FREE CASH FLOW, HOW DO YOU CALCULATE IT, AND WHY DOES IT MATTER IN AN LBO?
yup
