corporate finance final FIN 3154

When calculating a firm's financial cash flows, and specifically the operating NWC adjustment, match the isolated changes in operating current assets and liabilities with the appropriate cash adjustment.

A. Current assets increase -> cash decrease B. current assets decrease -> cash increase C. current liabilities increase -> cash increase D. current liabilities decrease -> cash decrease

Which of the following is a benefit of decreasing financial leverage (decreasing debt as a % of the capital structure)? A. Decreases cost of equity B. Increases Enterprise Value (EV) of Firm C. Executives and employees are working as hard as possible and making the best decisions D. Decreases Weighted Average Cost of Capital (WACC)

A. Decreases cost of equity

Which of the following statements is an accurate description of using Discounted Cash Flow analysis to value a firm? A. Discount forecasted free cash flows at the weighted-average cost of capital B. Discount forecasted free cash flows at the cost of equity C. Discounted Cash Flow analysis does not take account of expected future investment by the firm D. Discounted Cash Flow analysis values the Market Value of Equity of a firm

A. Discount forecasted free cash flows at the weighted-average cost of capital

In the constant growth DDM, a decrease in the required return (or cost of equity) is associated with what?

Increases the implied equity value per share

Under the trade-off view of the optimal capital structure, what is the actual enterprise value of the firm given the following factors: Present value of financial distress costs = $(10)mm Present value of tax shield on debt = $20mm Enterprise value of the unlevered firm = $100mm

$110 million

On the income statement, assume total depreciation of $500 is included in the COGS and the total amortization of $200 is included in non-operating other expenses, which is actually between EBIT and net income, and thus not subtracted when calculating EBIT. EBIT = $500. Cash taxes paid = $(250). Based on calculations of financial cash flows, what is the operating cash flows?

$750 = EBIT + depreciation - cash taxes paid = 500 + 500 - 250 = 750

On the income statement, assume the total depreciation of $300 is included in the general and administrative expenses and the total amortization of $200 is included in other expenses, both subtracted from EBIT. EBIT = $600. Cash taxes paid = $(200). What is the operating cash flow?

$900 = EBIT + depreciation + amortization - cash taxes paid = 600 + 300 + 200 - 200 = 900

What are the steps of a straight liquidation under chapter 7?

1. a petition is filed in federal court. debtor can file voluntarily or the creditors can file involuntary. 2. a bankruptcy trustee is elected by the creditors to take over the assets of the debtor firm. trustee will attempt to liquidate the firm's assets 3. when the assets are liquidated, after payment of the costs of administration, money is distributed to creditors 4. if any assets are leftover the shareholders get it

what are the steps of a bankruptcy reorganization under chapter 11? A. payments in cash, property, and securities are made to creditors and shareholders. the plan may provide for the issuance of new securities B. firm is given 120 days to submit a reorganization plan. if it does, the firm is given 180 days from the filing date to gain acceptance of the plan C. in most cases the debtor continues to run the business D. a voluntary or involuntary petition is filed E. creditors and shareholders divided into classes. approval by 1/2 of creditors who own 2/3 total outstanding debt F. if creditors accept, plan is confirmed by court G. federal judge either approves or denies petition

1. a voluntary or involuntary petition is filed 2. federal judge either approves or denies petition 3. in most cases the debtor continues to run the business 4. firm is given 120 days to submit a reorganization plan. if it does, the firm is given 180 days from the filing date to gain acceptance of the plan 5. creditors and shareholders divided into classes. approval by 1/2 of creditors who own 2/3 total outstanding debt 6. if creditors accept, plan is confirmed by court 7. payments in cash, property, and securities are made to creditors and shareholders. the plan may provide for the issuance of new securities

What is the proper order that liquidation proceeds are distributed according to the absolute priority rule?

1. admin expenses associated with liquidation 2. unsecured claims arising after filing involuntary bankruptcy 3. wages, salaries, and commissions 4. contributions to employee benefit plans 5.consumer claims 6. tax claims 7. secured and unsecured creditor's claims 8. preferred stockholder's claims 9. common stockholder's claims

Based on our discussions in class, approximately what percentage of firms who go through financial distress end up filing Chapter 7 (full liquidation)?

2.5%

When using IRR to evaluate independent project cash flows, which of the following is correct? A. Accept a financing project if the IRR is less than the required return. B. Accept a financing project if the IRR is greater than the required return. C. Accept an investing project if the IRR is less than the required return. D. Need a required return to calculate an IRR.

A. Accept a financing project if the IRR is less than the required return.

Which of the following statements about the cost of debt is correct? A. Cost of debt is generally lower than the cost of equity B. Cost of debt is lower for lower-rated debt by the credit agencies C. Cost of debt reflects the compensation to the firm's shareholders D. Credit risk premiums included in the cost of debt decrease as economic performance declines

A. Cost of debt is generally lower than the cost of equity

Which of the following statements about the cost of debt is incorrect? A. Cost of debt is lower for lower-rated debt by the credit agencies B. Cost of debt is generally lower than the cost of equity C. Credit risk premiums included in the cost of debt increase as economic performance declines D. Cost of debt reflects the compensation to the firm's lenders for its credit risk

A. Cost of debt is lower for lower-rated debt by the credit agencies

Which of the following should be included as a cash flow in evaluating an investment project? A. Costs associated with potential cash flows from alternative uses of assets used for this investment project. B. Costs of developing and testing the new project that have already been incurred and paid to make sure the project was one that was interesting C. Consulting and Investment Banking fees paid several years after the end of the project to analyze the firm's investment strategy D. Current corporate costs that existed prior to the project that would be allocated to the project if it were accepted

A. Costs associated with potential cash flows from alternative uses of assets used for this investment project.

Which of the following statements about the enterprise value multiples is incorrect? A. Enterprise Value Multiples allow you to estimate Enterprise Value when the firm of interest and its comparable companies have fundamentally different forecasted growth rates and sizes but other characteristics are the same B. To calculate an implied equity value per share from an Enterprise Value Multiple, you first calculate the firm's Enterprise Value, then subtract the value of debt and add the value of cash, and finally divide by the fully diluted shares outstanding C. Enterprise Value Multiples can be used to value a firm relative to multiples of comparable companies when the comparable firms have different policies regarding financial leverage (i.e. different capital structures) but other characteristics are the same D. When performing comparable company analysis, Enterprise Value Multiples are generally preferred

A. Enterprise Value Multiples allow you to estimate Enterprise Value when the firm of interest and its comparable companies have fundamentally different forecasted growth rates and sizes but other characteristics are the same

Which of the following statements about the Financial Cash Flows and Accounting (i.e. Indirect) Cash Flow Statement is true? A. Financial and Accounting Cash Flows adjust profitability for depreciation and amortization B. Financial uses net income as the profit measure in operating cash flow while Accounting uses EBIT. C. Financial includes interest in operating cash flow while Accounting uses interest in financing cash flow D. Financial typically breaks out the individual working capital items while Accounting makes one net adjustment for the change in net working capital.

A. Financial and Accounting Cash Flows adjust profitability for depreciation and amortization

Which of the following is an issue with the pecking-order theory? A. High cash flow firms use less debt, so they do not optimally benefit from the tax shield and management pressure B. Issues more debt than equity C. High cash flow firms use more debt, so they optimally benefit from the tax shield and management pressure D. Indicates a target Debt/Equity ratio

A. High cash flow firms use less debt, so they do not optimally benefit from the tax shield and management pressure

Which of the following statements about weighted average cost of capital (WACC) is correct? A. If possible, WACC should use market value weights for the costs of debt and equity B. WACC should use the coupon rate on a firm's bonds as the cost of debt C. WACC should use the US Treasury rate as the cost of debt when valuing firms D. If possible, WACC should use book value weights for the costs of debt and equity

A. If possible, WACC should use market value weights for the costs of debt and equity

Suppose a firm must choose between two machines having unequal lives. Both machines can do the same job, but they have different operating costs and will last for different time periods. The firm anticipates that both machines can and will need to be replaced indefinitely. Assume Project B has a lifetime of 16 years and Project A has a lifetime of 8 years. When evaluating the two mutually exclusive projects, which of the following is NOT correct? A. If the NPV of Project A is greater than the NPV of Project B, accept Project A B. Compare the Equivalent Annual Cost (the value of the level payment annuity that has the same PV as our original set of cash flows). If the EAC of Project B is greater than the EAC of Project A, accept Project A C. If the NPV of Project B is greater than the NPV of two Project As (both situations ending after 16 years), accept Project B D. If you use Equivalent Annual Cost, you will need to calculate the NPV for both projects

A. If the NPV of Project A is greater than the NPV of Project B, accept Project A

Suppose a firm must choose between two machines having unequal lives. Both machines can do the same job, but they have different operating costs and will last for different time periods. The firm anticipates that both machines can and will need to be replaced indefinitely. Assume Project A has a lifetime of 6 years and Project B has a lifetime of 3 years. When evaluating the two mutually exclusive projects, which of the following is incorrect? A. If the NPV of Project B is greater than the NPV of Project A, accept Project B B. If you use Equivalent Annual Cost, you will need to calculate the NPV for both projects C. If the NPV of Project A is greater than the NPV of two Project Bs (both situations ending after 6 years), accept Project A D>. Compare the Equivalent Annual Cost (the value of the level payment annuity that has the same PV as our original set of cash flows). If the EAC of Project A is greater than the EAC of Project B, accept Project B

A. If the NPV of Project B is greater than the NPV of Project A, accept Project B

From the firm's perspective, which of the following statements in isolation certainly indicates a net cash outflow? A. Issued $2,000 in short-term debt and retired $2,500 in long-term debt B. Net Income = $1,000 and the Change in Retained Earnings from 2018 to 2019 = $1,000 C. Common Stock and Additional Paid in Capital increases from 2018 to 2019 D. Gross Property, Plant, and Equipment decreases from 2018 to 2019

A. Issued $2,000 in short-term debt and retired $2,500 in long-term debt

Which of the following is NOT an advantage of Bankruptcy? A. Judges approve major business decisions B. Pay less taxes C. Discontinued accrual of interest on pre-bankruptcy unsecured debt D. New credit is available

A. Judges approve major business decisions

Which of the following is true of Debtor-In-Possession (DIP) financing? A. Involves using an existing lender for the bankrupt firm to provide additional loans to the bankrupt firm so that it can finance its working capital before liquidation B. Provides loans to a firm in Chapter 11 to provide it with funds for potential capital expansion C. Provides a firm in Chapter 11 Bankruptcy access to long-term debt financing in public markets so that it can continue to operate D. Makes formal bankruptcy reorganization less attractive than a private workout

C. Provides a firm in Chapter 11 Bankruptcy access to long-term debt financing in public markets so that it can continue to operate

All else equal, which of the following changes would NOT definitely increase or decrease the after-tax salvage value? In other words, which would you need additional information to know for sure if it would increase or decrease the after-tax salvage value? A. Lower initial investment B. Decrease Tax Rate C. Higher sale price D. More depreciation

A. Lower initial investment

Assuming reasonable assumptions are being used, which of the following accurately describes the most thorough approach to reviewing a project based on its Net Present Value (NPV)? A. Monte Carlo Simulation: An exercise that generates possible outcomes for a project based on a model of the underlying factors that drive project performance. B. Scenario Analysis: An exercise that observes the effect on a project of different situations with each situation involving many variable changes. C. Scenario Analysis: An exercise that generates possible outcomes for a project based on a model of the underlying factors that drive project performance. D. Monte Carlo Simulation: An exercise that observes the effect on a project of different situations with each situation involving many variable changes.

A. Monte Carlo Simulation: An exercise that generates possible outcomes for a project based on a model of the underlying factors that drive project performance.

Assuming reasonable assumptions are being used, which of the following accurately describes the most thorough approach to reviewing a project based on its Net Present Value (NPV)? A. Monte Carlo simulation B. scenario analysis C. sensitivity analysis D. break-even analysis

A. Monte Carlo simulation

James River has 4 divisions, all of which have different βetas. If James River uses its overall firm βeta to calculate a firm cost of capital that will be used for all 4 divisions in making investment decisions, which of the following could happen? In this context, positive and negative describe the NPV based on a risk-adjusted discount rate based on the project's risk/βeta (not the firm's risk/βeta), and low/high risk is judged relative to James River's firm βeta with low risk having a project βeta < the firm's βeta and high risk having a project βeta > the firm's βeta. A. Positive NPV, low risk projects could be incorrectly rejected B. All investment decisions should be correct C. Negative NPV, low risk projects could be incorrectly accepted D. Positive NPV, high risk projects could be incorrectly rejected

A. Positive NPV, low risk projects could be incorrectly rejected

Which of the following is true? A. Should use market value of debt when a company is in deep financial distress B. Should use book value of equity when a company is in deep financial distress C. Should use book value of equity when a company is not in financial distress D. Should use book value of debt when a company is in deep financial distress

A. Should use market value of debt when a company is in deep financial distress

Definitions of operating cash flows A. Top-down B. Bottom-up C. Tax-shield

A. Top-down = sales - cash costs - cash taxes 1B. bottom-up = (sales - cash costs - depreciation) * (1-tax rate) + depreciation 2B. bottom-up = net income + depreciation C. Tax-shield = (sales - cash costs) * (1-tax rate)+depreciation*tax rate

What is not free cash flow? A. Total cash available to all investors of the firm. Free Cash Flow must be used to pay creditors or pay shareholders. B. Operating Cash Flow + Operating Net Working Capital Adjustment + Investing Cash Flow C. Total cash available to all investors of the firm. D. Firm has discretion over Free Cash Flow to pay creditors, pay shareholders, or add cash to balance sheet

A. Total cash available to all investors of the firm. Free Cash Flow must be used to pay creditors or pay shareholders.

Which of the following is false? A. When evaluating a project, if the preliminary NPV calculation is greater than 0, then if the project is accepted, the project will definitely add value to the firm in reality B. Less depreciation has a negative effect on NPV C. Depreciation methodology (100% Bonus, MACRS, Straight-line, etc.) could change your investment decision D. If projects are mutually exclusive, Net Present Value (NPV), Profitability Index (PI), and Internal Rate of Return (IRR) do not always support the same decisions

A. When evaluating a project, if the preliminary NPV calculation is greater than 0, then if the project is accepted, the project will definitely add value to the firm in reality

Which of the following statements incorrectly describes something that happens during bankruptcies? A. Automatic stay granted at the time of the filing stops payments of both principal and interest to creditors B. Chapter 11 bankruptcy gives secured creditors the right to propose the first reorganization plan C. Chapter 7 bankruptcy rigidly follows absolute priority D. Chapter 11 bankruptcy rigidly follows absolute priority

B. Chapter 11 bankruptcy gives secured creditors the right to propose the first reorganization plan

What would cause cost of debt to decrease? A. Business risk increases B. Company releases higher than expected free cash flow guidance C. Interest Rate of comparable treasury or base yield increases D. Firm uses more financial leverage

B. Company releases higher than expected free cash flow guidance

which of the following is false? A. If projects are independent, Net Present Value (NPV), Profitability Index (PI), and Internal Rate of Return (IRR) always support the same decisions B. Accelerated depreciation has a positive effect on NPV C. When evaluating a project, if the NPV calculation is positive, the project will add value to the firm D. Depreciation methodology (100% Bonus, MACRS, Straight-line, etc.) could change your investment decision

C. When evaluating a project, if the NPV calculation is positive, the project will add value to the firm

Which of the below describes a situation when the discount rate is appropriately estimated? A. Capital budgeting decision that is much larger than normal or potentially different than what the company is used to, they should use WACC to reflect the risk B. Capital budgeting decision that is much larger than normal or potentially different than what the company is used to, they should apply a higher discount rate to reflect the risk C. Executives would assume that the business risk of the non-scale-enhancing project would be drastically different than the business risk of firms already in the industry D. Capital budgeting decision that is very similar to other projects that the company has previously done, the firm should apply a higher discount rate to reflect the risk

B. Correct Answer Capital budgeting decision that is much larger than normal or potentially different than what the company is used to, they should apply a higher discount rate to reflect the risk

Which of the following is NOT an indirect bankruptcy cost? A. Selling assets in illiquid markets B. Costs of legal representation for a bankruptcy proceeding C. Impaired ability to conduct business D. Lost managerial attention

B. Costs of legal representation for a bankruptcy proceeding

Which of the following is not a direct factor in assessing the business risk of a firm? A. Potential product, environmental, or employer liability B. Financial leverage C. Sensitivity of the firm's cash flows to macroeconomic fluctuations D. Volatility of input and output prices

B. Financial leverage

from the firm's perspective, which of the following statements in isolation certainly indicates a cash inflow? A. Issued $1,000 in short-term debt and retired $1,500 in long-term debt B. Gross Property, Plant, and Equipment decreases from 2018 to 2019 C. Treasury Stock increases in magnitude (becomes a higher negative number) from 2018 to 2019 D. Net Income = $1,000 and the Change in Retained Earnings from 2018 to 2019 = $500

B. Gross Property, Plant, and Equipment decreases from 2018 to 2019

Since inflation will likely occur during the expected life of a project, which of the following should you do? A. Ignore inflation in all cash flow forecasts and use a nominal discount rate B. Include inflation in all cash flow forecasts and use a nominal discount rate C. Include inflation in all cash flow forecasts and use a real discount rate D. Real cash flows discounted at nominal rates or nominal cash flows discounted at real rates

B. Include inflation in all cash flow forecasts and use a nominal discount rate

Since inflation will likely occur during the expected life of a project, which of the following should you NOT do? A. Ignore inflation in all cash flow forecasts and use a real discount rate B. Include inflation in all cash flow forecasts and use a real discount rate C. Real cash flows discounted at real rates or nominal cash flows discounted at nominal rates D. Include inflation in all cash flow forecasts and use a nominal discount rate

B. Include inflation in all cash flow forecasts and use a real discount rate

which of the following is not true about prepackaged bankruptcy? A. If the situation is simplistic enough, should always be prioritized over the normal Chapter 11 bankruptcy process B. Involves voluntary agreements between lenders and borrowers to modify a debt agreement to prevent the borrower from filing for bankruptcy C. Offers many of the advantages of a formal bankruptcy but is more efficient D.Forces holdouts to accept a bankruptcy reorganization

B. Involves voluntary agreements between lenders and borrowers to modify a debt agreement to prevent the borrower from filing for bankruptcy

Which of the following is not an option in asset restructuring? A. Selling major assets at their salvage value and getting as much cash as they can B. Issuing new securities C. Reducing capital spending and R&D spending D. Merging with another firm

B. Issuing new securities

All else equal, which of the following changes would definitely increase the after-tax salvage value? A. Higher initial investment B. Less depreciation C. Increase Tax Rate D. Lower sale price

B. Less depreciation

Which of the following is true about the trade off approach for the optimal capital structure? A. If benefits > costs, decrease debt B. Maximize difference between present value of tax shield on debt and present value of financial distress costs C. If benefits < costs, increase debt D. Actual Value Created / (Destroyed) by Financial Leverage = Present value of tax shield on debt + Present value of financial distress costs

B. Maximize difference between present value of tax shield on debt and present value of financial distress costs

Which company generally has a higher likelihood of liquidation? A. not enough info to tell B. both have the same likelihood C. low financial leverage D. high financial leverage

C. low financial leverage

Which of the following should not be included as a cash flow in evaluating an investment project? A. Future wages and salaries for current employees of the firm who will be assigned to work on the new project B. Costs associated with potential cash flows from alternative uses of assets used for this investment project. C. Costs of developing and testing the new project that have already been incurred and paid to make sure the project was one that was interesting D. Revenue in the future from sales of an existing product to new customers brought into the firm by the introduction of the new product

C. Costs of developing and testing the new project that have already been incurred and paid to make sure the project was one that was interesting

Which of the following 2 isolated changes would definitely increase the sustainable growth rate? A. Decrease Capital Intensity and Decrease Debt-Equity Ratio B. Increase Profit Margin and Increase Dividend Payout Ratio C. Decrease Capital Intensity and Increase Debt-Equity Ratio D. Decrease Profit Margin and Decrease Dividend Payout Ratio

C. Decrease Capital Intensity and Increase Debt-Equity Ratio

Which of the following statements is not an accurate description of using discounted cash flow analysis to value a firm? A. Discounted Cash Flow analysis values the Enterprise Value B. Discount forecasted free cash flows at the weighted-average cost of capital C. Discount forecasted free cash flows at the cost of equity D. Discounted Cash Flow analysis takes account of expected future investment by the firm

C. Discount forecasted free cash flows at the cost of equity

Which of the following is not a response to mitigate potential costs of financial distress? A. Bondholders price the risk up front and demand a higher interest rate to compensate for costs of financial distress B. Minimize the number of lenders C. Ensure that the company is only making large acquisitions and minimal capital expenditures D. Create Protective Covenants which try to stop agency costs and other bondholder negative corporate actions

C. Ensure that the company is only making large acquisitions and minimal capital expenditures

Which of the following statements about the Enterprise Value Multiples (as opposed to Price to Earnings (P/E) Multiples) is correct? A. Enterprise Value Multiples allow you to estimate the value of a firm by assuming its key characteristic (e.g., book value of assets) is valued in a different manner than for comparable companies B. To calculate an implied equity value per share from an Enterprise Value Multiple, you first calculate the firm's Enterprise Value, then add the value of debt, and finally divide by the fully diluted shares outstanding C. Enterprise Value Multiples can be used to value a firm relative to multiples of comparable companies when the comparable firms have different policies regarding financial leverage (i.e. different capital structures) but other characteristics are the same D. Enterprise Value Multiples allow you to estimate Enterprise Value when the firm of interest and its comparable companies have fundamentally different forecasted growth rates and sizes but other characteristics are the same

C. Enterprise Value Multiples can be used to value a firm relative to multiples of comparable companies when the comparable firms have different policies regarding financial leverage (i.e. different capital structures) but other characteristics are the same

Which of the following does not accurately describe an agency cost of financial distress? A. Stockholders of a firm with a significant probability of bankruptcy often find that new investment helps the bondholders at the stockholders' expense, so they would decide to not invest in positive NPV projects B. Stockholders will start to try to pay themselves more or take perks from the company in the near-term C. Firms should invest in low-risk projects that add value that will most likely only benefit creditors who are likely to take over the firm in bankruptcy D. Firms in distress have the incentive to consider risky investment alternatives that offer some chance of recovery from insolvency

C. Firms should invest in low-risk projects that add value that will most likely only benefit creditors who are likely to take over the firm in bankruptcy

Which of the following statements about holdout issues in resolving financial distress is correct? A. Holdout issues are worse in Chapter 11 bankruptcy, which require unanimity, vs. private workouts B. Holdout issues are worse in private workouts, which do not require unanimity, vs. Chapter 11 bankruptcy C. Holdout issues are worse in private workouts, which require unanimity, vs. Chapter 11 bankruptcy D. Both are the same

C. Holdout issues are worse in private workouts, which require unanimity, vs. Chapter 11 bankruptcy

which of the following isolated changes would increase the sustainable growth rate? A. Increase Dividend Payout Ratio B. Decrease Debt-Equity Ratio C. Increase Capital Intensity D. Decrease Profit Margin

C. Increase Capital Intensity

When performing precedent transaction analysis, which is an additional consideration that is not needed for comparable companies analysis? A. Size of transaction B. Industry of transaction C. Geography of transaction D. Date of transaction

D. Date of transaction

which of the following statements about the financial cash flows and accounting (i.e. indirect) cash flow statement is true? A. Financial uses net income as the profit measure in operating cash flow while Accounting uses EBIT. B. Financial adjusts accounting profitability for depreciation and amortization while Accounting does not make an adjustment for these items. C. Financial typically breaks out the individual working capital items while Accounting makes one net adjustment for the change in net working capital. D. Financial uses EBIT as the profit measure in operating cash flow while Accounting uses net income.

D. Financial uses EBIT as the profit measure in operating cash flow while Accounting uses net income.

Which of the following is NOT a correct description of Section 363 cases? A. Section 363 cases are different from traditional Chapter 11 cases in that they expedite the process B. Section 363 cases are similar to traditional Chapter 11 cases in that the firm continues to operate with a new set of financial claims C. Section 363 cases are different from traditional Chapter 11 cases in that a new stockholder bids to buy the firm out of bankruptcy D. In Section 363 cases, pre-bankruptcy shareholders benefit at the expense of pre-bankruptcy creditors

D. In Section 363 cases, pre-bankruptcy shareholders benefit at the expense of pre-bankruptcy creditors

When using IRR to evaluate independent project cash flows, which of the following isn't always correct? A. Do not need a required return to calculate an IRR. B. Accept an investing project if the IRR is greater than the required return. C. Accept a financing project if the IRR is less than the required return. D. Need to use Modified IRR (MIRR) because there will be multiple changes in the sign of cash flows

D. Need to use Modified IRR (MIRR) because there will be multiple changes in the sign of cash flows

What are the 3 most common valuation techniques?

Discounted cash flow analysis, comparable company analysis, precedent transaction analysis

Based on the DDM, what are the 2 components of the required return (cost of equity) of a stock?

Dividend/price + growth rate

who benefits the least from the tax shield?

IRS

Which is greater: internal growth rate or sustainable growth rate? Why?

Sustainable growth rate; allows for debt financing

What is free cash flow?

Total cash available to all investors of the firm. Firm has discretion over FCF to pay creditors, pay shareholders, or add cash to balance.

Assuming no transaction costs, no financial distress/bankruptcy costs, and individuals and corporations borrow at same rate, how does financial leverage affect Weighted Average Cost of Capital (WACC) without taxes? With taxes?

Without taxes, WACC is unaffected by capital structure; With taxes, WACC decreases as financial leverage increases

What bankruptcy procedure is most likely to take the longest?

chapter 11

What does it mean if two projects are independent?

accepting one of the projects doesn't affect your ability to accept the other project

What is the likely order in which a firm might go through restructuring activities in response to financial distress?

adjust operating decisions to improve operating cash flow, attempt a private workout, file for chapter 11 bankruptcy

What is the most commonly used approach for valuing projects with financial leverage?

adjusting discount rate (WACC) for the increase in financial leverage

default

borrower fails to make a payment at the scheduled time or abide by the terms of the loan

You are a financial analyst at a large corporation, and your CFO wants to determine how much COVID or the tax implications of the U.S. Presidential Election can negatively affect a project that you are evaluating before the NPV changes from positive to negative. Which analysis is he most likely asking you to perform?

break-even analysis

What has the highest required return in the capital structure?

common equity

you would like to compare your firm's capital structure to that of your competitors, but your competitors are much larger in size than your firm. what is the best way to compare costs across your industry?

common-size balance sheet

you would like to compare your firm's cost structure to that of your competitors. however, your competitors are much larger in size than your firm. what is the best way to compare costs across your industry?

common-size income statement

What is debtor in possession financing?

debt issued during a formal bankruptcy that is senior to all previously incurred debt

all else equal, what does decreasing the discount rate do to the discounted payback period?

decreases

in the zero growth DDM, an increase in the required return (or cost of equity) is associated with what?

decreases the implied equity value per share

based on the DDM what are the two components of the required return (cost of equity) of a stock?

dividend yield + capital gains

what are prepackaged bankruptcies?

firm and most of its creditors agree to private reorganization plan outside the formal bankruptcy and then the firm files a formal bankruptcy under chapter 11

based on our discussions of the circular flow/balance sheet model of a firm, how do you describe the investing decision?

firm decides how to split financing cash flows between short-term and long-term assets. cannot be a cash inflow

based on our discussion of the circular flow/balance sheet model of a firm, what best describes the payout decision?

firm decides how to split operating cash flows between cash distributed to investors and cash reinvested in the firm's operations and assets. cannot be a cash inflow

financial distress

firm is having difficulty generating the cash necessary to meet debt service requirements or fulfilling other terms of an indenture and the firm is forced to take corrective action

pecking-order theory

firms prefer to issue debt rather than equity if internal financing is insufficient

signaling theory

firms with high anticipated profits will take on a high level of debt, they have more pre-tax income to shield through interest and higher debt

Incremental IRR can be used for making investment decisions that address situations in which projects of different scale are mutually exclusive. Assume project B is larger than Project A, so investment and cash flows are higher. What does the incremental IRR tell us?

if incremental IRR is greater than the discount rate, choose project B. Means NPV(B) > NPV(A). if incremental IRR is lower than the discount rate, choose project A. means NPV(A) > NPV(B)

agency cost of equity-free cash flow theory

increase in debt will reduce the ability of managers to pursue wasteful activities more effectively than dividend increases.

If you were asked to find the below terms of a bond, where should you look? ◦The basic terms of the bonds ◦The total amount of bonds issued ◦A description of property used as security, if applicable ◦Sinking fund provisions ◦Call provisions ◦Details of protective covenants

indenture

What is the highest cost of financial distress?

indirect costs

assuming taxes, no bankruptcy/financial distress costs, and perpetual debt, the enterprise value of a levered firm exceeds the enterprise value of an unlevered firm by what amount?

interest*tax rate/interest rate

What are the 5 key strategic financial decisions that a firm must make?

investing, operating, payout, liquidity, financing

Who benefits the most from bankruptcy?

lawyers

bankruptcy

legal proceeding and can be done voluntarily by firm or involuntarily by creditors

What is a good attribute for a company to have high leverage?

low cyclicality

What is the primary objective of the managers of the firm?

maximize the equity value of the firm

What is the best technique to value a company?

multiple valuation techniques

What is the best way to calculate net change in cash for the projected year, assuming we want cash to be the "plug" variable to make the balance sheet balance?

net change in cash = free cash flow + cash flow from/(to) creditors + cash flow from/(to) shareholders

What does decreasing the discount rate do to payback period?

nothing

trade-off theory

optimize PV of tax shield on debt and PV of financial distress costs

Which is most likely to have the highest valuation: discounted cash flow analysis, precedent transaction analysis, or comparable companies analysis?

precedent transaction analysis

Who benefits primarily from the tax shield?

shareholders

insolvency

value of the firm's assets is less than the value of the debt