Fin 431 - Exam 2

Extended DuPont Equation

Decreases in either tax burden ratio or the interest burden ratio tends to decrease ROE. In general, increases in leverage ratio and asset turnover ratio --> higher ROE *BUT* more leverage does not always lead to higher ROE. As leverage rises, so does the interest burden. Hence, the positive effects of leverage can be offset by the higher interest payments that accompany more debt.

What about P/E ratio?

Depends on: - How fast is the current $1 in EPS going to grow [g]? - How risky is the $1 in the future [rE]? - What fraction of every $1 in earnings can shareholders have vs. what fraction remains in the firm to generate growth [1-b]? b: plowback = retention rate = how much money reinvested into firm for growth & not paid out as dividends

Empirical evidence suggests that upon announcement of a new equity issue, current stock prices generally behave how?

Drop, perhaps because the new issue reflects management's view that common stock is currently overpriced.

Is Common Equity Value / EBITDA a consistent multiple?

EBITDA (the denominator) does not represent cash flow available for equity holders (the numerator) since EBITDA is before payments to debt holders (the "BI" in EBITDA stands for "before interest") and before taxes. EBITDA is available to pay all debt and equity claims, so it is inappropriate to just have Equity Value in the numerator. Valid Multiple = Enterprise Value/EBITDA

EBITDA = EBIT + D + A = 100 + 10 + 15 = 125

EBITDA is often used as a starting point in computing free cash flows to the firm in DCF (Discounted Cash Flow) valuation models. ABC Inc. has the following reported information: operating income is $100 million, cost of goods sold is $45 million, depreciation is $10 million and amortization is $15 million. What is EBITDA?

How do accretion & dilution work?

Each share of the A's company becomes one share of AT (the new company). Thus, accretion/dilution analysis compares the A's pre-deal EPS with AT's post-deal EPS. - If EPS(AT) > EPS(A) , the deal is accretive; otherwise, it is dilutive.

Why Don't We Use Earnings to Build Valuation Models?

Earnings is an accountant's number. It can be intentionally distorted. "CFOs believe that in any given period a remarkable 20% of firms intentionally distort earnings, even though they are adhering to generally accepted accounting principles."

Basic Firm CF Valuation

Enterprise Value: V = D + E PV of the FCFs = Enterprise Value

Ratio Analysis

Express relationships among data that can be used for comparisons across time (for the same firm) & across different firms

Fama-French 3-Factor Model

Fama & French observed that 2 classes of stocks tend to outperform market as a whole - Small caps: outperform large caps companies (higher risk) - High B-to-M ratio: value stocks outperform growth stocks

Initial Public Offering (IPO)

First sale of firm's equity to the market. This is when private investors (like venture capitalist) cash in. After the IPO, equity is listed on stock exchange.

Do you think diversification (buying firms which are in unrelated industries, i.e., creating conglomerates) creates value?

For public firms, a takeover, motivated only by diversification considerations, has no effect on the combined value of the 2 firms involved in the takeover. The value of the combined firms will always be the sum of the values of the independent firms. (The shareholders can diversify their portfolio themselves.) For private firms or closely held firms, where the owners may not be diversified personally, there might be a potential value gain from diversification.

Private Equity

For start-up firms & firms in financial trouble, public equity market is often not available *Private placements*: - Avoid costly registration procedures associated w/ public issues - Issues restricted to few knowledgeable investors - Drawback: Securities cannot be easily resold

Green Shoe Option

IPO's best friend. Over-allotment option that permits underwriter buy up to additional 15% shares @ offering price. They can oversell all 115% shares & then buy back 15% to stabilize the share price according to demand.

Now you know that cash deals send a positive signal to the market. But what can you do if you really have confidence on the deal as an acquirer but cannot pay by cash due to some capital structure-related reasons?

If cash deal is not possible for capital structure-related reasons, you, as an acquirer can demonstrate confidence by bearing more pre-closing market risk through fixed value offer.

Why P/E is important?

In theory: there is no difference to DCF! Same result. In practice: we must be comfortable with the assumptions - DCF: can forecast FCF, measure WACC (need rE) - Multiples: think we are in "steady state", think we are "similar" to other firms, if necessary can adjust for differences

Setting the Offer Price

Issuer/underwriter face a potential cost if the offering price is set too high or too low. Book-building Mechanism: - Issuer & underwriter set indicative price range - Road-show - Underwriter collects bids from investors (price/quantity) to learn about true value of stock - Underwriter sets IPO price & place shares - Underwriter rations shares (allocate shares between large-frequent-limit bidders)

Earnings Management

Issuers can report unusually high earnings by adopting discretionary accounting accrual adjustments that raise earnings to actual CFs. - If buyers unaware, they could pay a too high of a price - As info about the firm revealed over time, investors realize that earnings is not momentum - The greater the earnings management, the larger the ultimate price correction is

M&A Example 2008

Microsoft's acquisition of Yahoo (never happened, otherwise it would have been the biggest technology deal to ever take place). *What was the motivation for Microsoft to acquire Yahoo?* - Both competing against Google in search engine (Yahoo + Microsoft = 30% market >< Google = 70%). Microsoft wanted to potentially gain market share & boost online presence. Yahoo did not just want to be acquired. Yahoo was waiting for the "White Knight" to acquire them. *Can Google acquire Yahoo then?* - No, because of the Antitrust Laws (regulatory laws) since Google is already the dominant player of the market. The law is there to protect market from monopolies Microsoft sent a letter to Yahoo's BoD, offering 62% higher than share price at the time. *Why communicate w/ BoD instead of shareholders?* Microsoft attempted a friendly acquisition. Microsoft should only switch to hostile if attempt fails b/c BoD disrupts acquisition *How can BoD disrupt acquisition?* Takeover Defense

Lock-Up Clause

Most IPOs have this lock-up clause. - Prohibit insiders & other pre-IPO shareholders from selling any of their shares for a specified period - Typically lasts 180 days & covers most shares not sold in IPOs - Terms of the lock-up disclosed in IPO prospectus

Can the long-term stable growth rate (i.e., the perpetuity growth rate) be greater than the growth rate of the economy in which it operates?

NOPE

Why do we prefer NPV over IRR for conflicting results while making capital budgeting decisions?

NPV assumes cash flows are reinvested at the cost of capital (discount rate), which is a more realistic assumption. IRR assumes reinvestment at IRR (not realistic).

Saturday Night Special

Offer made to stockholders just before the market's close on Friday. It caught target off guard on the weekend, benefit the acquirer

XYZ is currently trading at $85 per share. It is expected to pay a dividend of $3 per share next year. Investors require an 8% return on their investment. What should you expect the share price to be next year (after the dividend is paid)? What is the company's growth rate?

Option 1: Because it asks for share price AFTER dividend is paid --> treat dividend as an extra $3 w/o relation to the P1 --> in year 2, share price = P1 + $3 --> P1 is AFTER dividend as it does not include $3. Calculate g using Dividend Growth model Option 2: Use growth rate for both calculations. P1 = P0 (1+g) = $85 x (1 + 4.47%) = $88.8

Red Herring

Preliminary prospectus. Name comes from the warning, printed in red, that information in the document is still being reviewed by the SEC & is subject to change.

Primary shares >< Secondary shares

Primary shares: New shares issued in IPO by company (proceeds from selling the shares go to the company) Secondary shares: existing shares sold by insiders (proceeds go to old shareholders, number of shares does not change)

Golden Parachutes

Provisions in the employment contracts of key executives that provide them with sizeable compensation if the firm is taken over.

Why ROE is so important?

ROE = net income / shareholder's equity Measure of how well a company's management creates value for its shareholders If this number goes up, it is generally a good sign for the company as it is showing that the rate of return on the shareholders' equity is rising. Problem is this number can also rise simply when the company takes on more debt, thereby decreasing shareholder equity. This would increase the company's leverage, which could be a good thing, but it will also make the stock more risky --> higher interest burden.

Recall the HBS Case on Blaine Kitchenware that we discussed in class. How high in your opinion are the expected costs of financial distress for Blaine Kitchenware under the status quo (i.e., assuming no recapitalization)?

Since Blaine has no debt and a lot of excess cash, the probability of becoming financially distressed is zero, and so are the expected costs of distress.

Shark Repellent

Slang term for any one of a number of measures taken by a company to fend off an unwanted or hostile takeover attempt. ➢ Examples: poison pills, scorched earth policies - *Poison Pills*: T makes shares of its company unfavorable to A (Flip-Over, Flip-In,Voting Plans, Shadow Pill, Chewable Pill, BankMail Pill) - *Scorched Earth Policies*: selling off assets, taking on high debt, and damaging the company if it is purchased. In extreme cases, a scorched earth policy might end up being a "suicide pill."

Heinz hires the Boston Consulting Group (BCG) to evaluate whether a new product line should be launched. The consulting fees are paid no matter what. Should you include the consulting fees in your capital budgeting decision? And, why?

Sunk costs should not be included in incremental cash flows. Valuation is always forward looking.

Pac Man

T tries to acquire A. In an attempt to scare off the would-be acquirers, the takeover T may use any method to acquire the other company, including dipping into its war chest for cash to buy a majority stake in the other company 2. The standoff is usually resolved when one of the parties finds a "white knight" to help. In the actual Pac-Man video game, the player has several ghosts chasing and trying to eliminate it. If the player eats a power pellet, he may turn around and eat the ghosts.

Accretive bad deals

Target's P/E ratio is low for a good reason (may be because it is risky or is in a market with no growth). If T is fairly valued and A with a high P/E pays a premium to buy it, A's EPS will go up, showing a nice growth trend. But the growth is illusory- the deal will actually destroy value, because the company was fairly valued in the first place.

Can the long-term stable growth rate (i.e., the perpetuity growth rate) be less than the inflation rate?

Terminal value cannot be < than inflation because then who would invest if your company is doing worse than inflation rate.

DuPont Analysis

The DuPont Analysis is a way to break down ROE to see what changes are driving the changes in ROE. For instance, a firm could have a *high volume/low margin* strategy, which would be reflected in high asset turnover but low profit margins. - Net PM: how well a firm control costs - Asset Turnover: how well a firm manage assets - Equity Multiplier: measure financial leverage

Cooling-off Period

The period after a company's prospectus has been filed with the SEC & before IPO. Company's relations w/ investors are restricted.

Who would be typically willing to pay more for a company, a financial buyer or a strategic buyer and why?

The strategic buyer. Because the strategic acquirer can realize *revenue and cost synergies* that the private equity firm cannot unless it combines the company with a complementary portfolio company. Those synergies boost the effective valuation for the target company.

Notes on Terminal Value

Think of it as ... if you're going to sell your business this year, how much is it worth? - Normally calculated when company's financials have stabilized - Often represents a large fraction of firm's value (sometimes >100%). Value is very sensitive to the assumed g. (a) Justify the assumption for g with an economic argument (e.g. growth in the economy/product market) (b) Do a sensitivity analysis on g & WACC (c) Use a multiple approach

Types of Offering

Traditional negotiated cash offers: - *Firm commitment offer*: Investment bankers buy a number of shares & sells them to investors @ high price - *Best efforts offer*: Investment bankers promises to sell @ X price (agreed upon). No guarantee how much cash can be raised. Offer can be withdrawn Privileged subscription: - *Rights offer*: Firm offers new stock directly to existing shareholders. There's a fixed period for shareholders to decide whether to subscribe or not. If not, they can sell their rights. Private: - *Direct placement*: Securities sold directly to buyer

Mergers & Acquisitions (M&A)

Transactions that transfer or consolidate control in a corporation Key players: - Acquirer (A1) - can be new shareholder or existing shareholder increasing its ownership in T - Target (T) - Rival Acquirer (A2) - Investment Banker In a merger the companies are close to the same size, whereas in an acquisition the buyer is significantly larger.

Do not trust your investment bankers or anyone else in the deal to look out for your interests; they have their own. That is your job.

True

Don't assume synergies last forever, don't assume you can get them immediately ... but: if you don't get significant synergies in year 1, you may never get them.

True

Google/Apple are partly banks/hedge-funds for having a lot of cash & invest in so many financial assets

True

In valuation, academics believe in Intrinsic Valuation. Practitioners believe in Public Comparable Analysis. T or F?

True

In a world with corporate taxes, but without any other frictions (e.g., no bankruptcy costs, informational frictions etc.), the optimal way to finance a firm is with as much leverage (the ratio of debt over equity) as possible. Is this statement true or false, and why?

True. There is only an upside to debt, no downside, so optimal capital structure is highest possible debt level

Public Comparable Analysis (Relative Valuation)

Valuing a company based on what similar companies are worth. 1. Select companies (5-10 public companies) - Industry - Geography - Size (market cap, revenue, EBITDA) - Date (only for earlier transactions) 2. Find the data for your companies - Equity/Enterprise - Historic metrics - Revenues, EBITDA,... 3. Select the multiples to use - Numerator & denominator consistent with each other

Law of One Price

Valuing objects is easier in relative terms. The price of an identical security/asset traded anywhere should have the same price regardless of location when currency exchange rates are taken into consideration, if it is traded in a free market with no trade restrictions (differences between asset prices in different locations should be eliminated b/c of arbitrage)

White Knight

When target firm cannot defend itself against the hostile acquirer, it will seek another firm to acquire it (one more acceptable to management).

Why Don't We Use Dividends to Build Valuation Models?

Yes, we can use dividends in some cases, but in most firms dividends are discretionary & smoothed and not all firms pay regular dividends. Instead, we want something that is not discretionary

Can the long-term stable growth rate (i.e., the perpetuity growth rate) be greater than WACC?

g cannot be greater than WACC b/c if it does, it means that the company going forward will perform worse and worse so who would want to buy it...? Terminal value is based on the assumption that company exists forever.

A stock currently pays a dividend of $2.00 per share. Expected dividend growth is 20% for the next 3 years and then is expected to revert to 7% thereafter indefinitely. The required rate of return on this stock is 15%. The stock's current intrinsic value is?

$36.93

Which of the following statements is FALSE? (a) The more cash the firm uses to repurchase shares, the less it has available to pay dividends (b) Free cash flow measures the cash generated by the firm after payments to debt or equity holders are considered (c) We estimate a project's value by computing the present value of the project's FCF (d) It is possible that there is no discount rate that will set the NPV equal to zero (e) For most investment opportunities expenses occur initially and cash is received later

(b) Because FCF is cash generated by the firm BEFORE payments to debt and equity holders

4 Reasons Why We're Doing Valuation of Corporation

*#1*: We want to know what something is worth to decide what to *pay* for to make a good return *#2*: We want to understand firms & *value drivers* *#3*: We want to study how *uncertainty* impact firm value *#4*: Different kinds of buyers might be willing to pay *different prices* for the same company (Ex: companies in the same industry when doing M&A will be willing to pay more because of synergy)

Hostile Takeover Techniques

*1. Toehold Acquisition*: Buy shares in the open market. *2. Tender Offer*: Bypass T's management by asking shareholders to sell (tender) their stock. [Public announcement ("Will pay $75 per share")] *3. Proxy Fight*: Propose a slate of directors at annual shareholders' meeting. Majority of votes → Your nominees win - If nominees constitute a majority of BOD →"Control"

M&A can be classified by the disposition of T's BoD. Elaborate (1) Friendly Acquisition - T's BoD supports transaction

*Deal Structure*: T's BoD & A try to structure the deal so as to get it through while maintaining T's value *Fiduciary Duties*: Conflict of Interests - T's SHs want best price; T's BoD may want to keep their jobs by offering A a sweet deal *Deal Risks*: Need to anticipate risks, minimize them & decide which party bears them

Process of IPO

*Goal*: promote efficient flow of information about securities & securities' markets. Regulation by SEC. 1. Select underwriter 2. Letter of intent 3. Registration statement & due diligence 4. *Red Herring* (preliminary prospectus) 5. Distribute prospectus & start road shows 6. Book-building 7. Day before the offer date: pricing & allocation 8. Public offering date: stock issued & begin trading 9. Aftermarket price stabilization 10. 180 days (usually) lock-up for insiders

Types of Mergers (M&A)

*Horizontal Merger*: between competing companies *Vertical Merger*: between buyer-seller relationship companies *Conglomerate Mergers*: neither competitors not buyer-seller relationship

Basic Types of Securities Transactions

*Long Purchase*: Buy low, sell high *Short Selling*: Sell high, buy low. Investors borrow securities held in "street names" from broker, short sell them when market declines, then buy them again when price is low. - Normally motivated by bear market - *Hypothecation Agreement* gives broker the right to lend shares to someone else - Short seller must return what was borrowed at some point in the future & must pay dividends to lender

Types of Buyers (M&A)

*Strategic Acquirer (Synergistic)*: in the game for a long run, hopes to achieve economies of scale, hopes to realize synergy & run the company. - Another company in the same industry/business - An entrepreneur who wants to run that business *Financial Acquirer*: short-term goal of restructuring the acquired company, improve CFs, unlock hidden values & sell company @ higher price in near future. - Venture Capital Firms - Private Equity Firms - Pension Funds - Endowments - Mutual Funds

M&A can be classified by the disposition of T's BoD. Elaborate (2) Hostile Takeover - T's BoD resists transaction

*Takeover Defense*: How can T defend itself against unwanted A? *Fiduciary Duties*: Does T's BoD have a valid reason to resist the transaction? *Creeping Takeover*: bidder slowly acquires toehold in the market, attempt to avoid big premium & take advantage of opportunistic additions to holding

Underwriter & Syndication Roles

*Underwriter*: Investment banks hired to assist in the offering. - Conduct due diligence - File documentation with SEC - Prepare Red Herring - Prepare Prospectus - Conduct marketing campaign - Organize a "road show" - Price & place new securities - Provide aftermarket price support - Provide analyst coverage *Syndicate*: most IPOs are sold by investment bank syndicates (many investment bankers). Higher number of lead managers = Higher number of analysts following the stock after issued. - Share risks among participants - Maximize distribution of issue - Compensated by underwriting spread = price paid to issuer - price received from investor

Why staying private? Why not going public?

- *Costly process* (Direct costs - underwriter fees, accounting & legal fees & Under-pricing) - *Increased public disclosure* (few requirements for reporting + not subject to SEC if private; costs of disclosure; loss of confidentiality) - *Costs of dealing w/ public shareholders* - *Vulnerability to control contests* - *ST market movements maybe a distraction*

Advantages of IPO

- *Relaxing financing constraints* (getting more financing & facilitate access to external capital in the future) - *Portfolio diversification for founders* (private founders may invest too much in a company, now that company's public, they can better diversify) - *Increased liquidity of stock* (lowers WACC) - *Establishing MP as benchmark* (makes performance-based compensation easier) - *Monitoring by investors* (increase credibility w/ customers, suppliers, employees) - *Availability of traded shares for acquisitions*

Pre-IPO Stages of Financing

- *Seed-Money Stage*: small money to prove a concept/develop a product - *Start-Up*: Funds to pay for marketing & product refinement - *First-Round Financing*: more money for sales & manufacturing - *Second-Round Financing*: money earmarked for working capital for a firm that's currently selling its product but still losing money - *Third-Round Financing*: finance for a firm to be at least break even & for expansion (mezzanine financing) - *Fourth-Round Financing*: finance for a firm to go public w/in 6 months (bridge financing)

Why do you think corporations hold cash? (5 Motives)

- *Transaction Motive*: cash is needed for operations - *Precautionary Motive*: to cope with adverse shocks in financial markets - *Tax Motive*: tax consequences ~ repatriating foreign earnings (U.S. taxes foreign operations of domestic firms and grants tax credits for foreign income taxes paid abroad. These taxes = foreign income taxes paid - tax payments that would be due if foreign earnings were taxed at the U.S. rate, and the difference can be deferred until earnings are repatriated --> Tax burden creates incentives to retain earnings abroad as cash) - *Agency Motive*: entrenched managers are inclined to hold large cash holdings (because they do not want to pay them out for shareholders but instead, maybe looking for opportunities to enhance their own interests with projects...) - *Speculative Motive*: just in case a great investment opportunity comes along

Name 3 Valuation Methods

- Absolute: DCF, APV (Adjusted PV), Real Options - Mix: Value early CFs explicitly, then apply for a multiple for continuation value - Relative: Trading & transaction multiples: P/E, EV/EBITDA, EV/FCF, Market-to-Book, ...

Advantages of DCF (Absolute Valuation)

- CF based, reflects value of projected FCF --> fundamental approach to valuation than using multiples-based methods - Market independent to a certain extent (bubbles, distressed periods...) - Allows analyst to run multiple financial performance scenarios, ... --> more flexible - Does not rely entirely on comparable companies --> self-sufficient

Review of WACCs (things to be aware of)

- D/E level: anticipated market value (BV of D is OK, BV of E is NEVER OK) - Using WACC means you're comfortable with the assumption that D/E will be constant in the future. Firm will adjust the amount of debt constantly to track changes in firm's value. If you think the DOLLAR debt level is easier to forecast (maybe b/c D/E will vary predictably), then use *adjusted PV*

Disadvantages of DCF (Absolute Valuation)

- Depends on forecasts --> challenging, can change - Depends on many assumption - PV of terminal value decreases relevance of projection period's annual FCF - Does not provide flexibility to change capital structure over the projection period

Disadvantages of Multiples

- Difficult to find true comparable (assume all comparable are alike in g, WACC, leverage...) - Cannot incorporate firm-specific info - Differences in accounting principles can affect multiples - If everyone uses multiples, who does the actual fundamental analysis?

Why do managers care so much about accretion vs. dilution?

- For public companies, EPS is the most universally used measure of management team's performance. - Good managers deliver consistent growth in EPS.

Advantages of Multiples

- Incorporates info from other valuation in a simple way - Embodies market's view about discount rate & g - Can provide benchmark by ensuring valuation is consistent w/ other firms

Why do firms merge or acquire other firms?

- Increase market power - Acquire financial strength - Tax loss carry forwards - Acquire specific product lines - Achieve synergies - Gain economies of scale

Seasoned Equity Offerings (SEO)

- MV of existing equity drops on announcement of seasoned equity offering Maybe...managers know their stocks are overvalued Maybe...managers want to reduce their D/E ratio (financial distress) Maybe...managers have problems w/ falling earnings/earnings management Firms improve operating performance & reported earnings prior to SEO but those improvements are not sustained after SEO.

Carhart 4-Factor Model

- Momentum: a stock which has performed well recently will continue to perform well & the stock which has performed poorly recently will also continue to perform poorly.

Why is valuation important?

- Need to understand valuation to make corporate finance decisions that maximize value - Valuation models help us understand the firm

Why having Lock-Up Clause?

- Reassure market that key people holding control of the company will not sell out in intermediate aftermarket - Provides credible signal that insiders believe MP will keep increasing - Aids underwriter's price support efforts by temporarily constraining supply of shares

Types of Costs of Issuing Securities

- Spread/underwriting discount (underwriter's buying price - offering price) - Direct expense: legal fees, mailing fees... - Indirect expense: management time - Green Shoe Option: option valuable for investors - Underpricing

Accretion/dilution analysis can be used to determine:

- The capacity of A to pay a premium for T - Optimal form of consideration (cash, stock, other securities, combination)

How does market react when acquirer uses cash & when when uses stocks to finance M&A?

- Using cash: signals confidence & discipline in saving cash for future operating decisions - Using stocks: company thinks it's overvalued, lack of confidence in synergies

Classes of Ratios (5)

1. *Liquidity Ratios*: ability to pay ST obligations (CR, quick ratio...) 2. *Solvency Ratios*: financial leverage + ability to meet LT obligations (D/E, average TA / average TE..) 3. *Profitability Ratios*: how well the firm generates operating profits and net profits from sales (Net PM, operating PM...) 4. *Activity Ratios*: efficiency in utilizing assets (asset turnover, inventory turnover,...) 5. *Valuation Ratios*: ratios used in Relative Valuation (P/E, P/S, EPS...)

3 Anomalies with IPOs (3 IPOs Puzzles)

1. *Underpricing* - Listing of IPO below its market value. When the offer price of a stock is lower than the price of the first trade, the stock is considered to be underpriced. High average return on IPO day (*Underprice = closing price 1st day - IPO offer price*) - Average underprice in US = 16% (IPOs are underpriced on average) - *Winner's Curse*: you get what you wanted only because no one else was prepared to pay as much. - Some IPO investors are more informed about true value of IPO shares than others. *Overpriced*: uninformed investors buy in *Underpriced*: both uninformed & informed investors buy in --> Uninformed investors get a few "good" shares & many "bad" shares --> Underpricing is necessary to induce uninformed investors to participate in IPOs 2. *Hot-Issued Market* - IPOs come in waves ~ hot issue market. Largely caused by firms taking advantage of high prices in IPO markets. - IPOs from hot issue years have worse subsequent returns than those from other years 3. *Poor LT Performance* - IPO stocks underpeform other firms of similar size 3-5y after IPO. - Seen in IPOs of relatively small/younger firm - IPO investors are too optimistic about firm's prospects, don't take into account: earnings mgmt by issuers before IPO; market timing by issuers; windows of opportunity

Equity Value vs. Enterprise Value

1. Equity Value = Market Cap = (price/share) x (total shares outstanding) Value of a business to owners after they account for any obligations to creditors, etc. 2. Enterprise Value = Equity Value + Debt + PS + MI - Excess Cash (Debts & Debt-like instruments) Value of a business before accounting for any obligations to creditors, etc.

Hostile Takeover

1. When T's management fights the tender offer. 2. A must carry offer to T's shareholders. 3. This strategy is generally nasty and expensive - an effort frequently carried out to a questionable conclusion. - Good deal for T's stockholders. - Bad deal for A's stockholders.

A firm has a debt-to-equity ratio of 1. Its cost of equity is 16%, and its cost of debt is 8%. If there are no taxes or other imperfections, what would be its cost of equity if the debt-to-equity ratio were 0?

12%

- Beta = 1.197. - Target D/E ratio = 0.70. - The expected return on the market portfolio = 16 - Treasury bills currently yield 8% per annum. - 1 year, $1,000 par value bonds carry a 7% annual coupon and are currently selling for $972.73. - The yield on OMWI's longer-term debt is equal to the yield on its one-year bonds. - Corporate tax rate is 34%. WACC?

13.0564%

Prospectus

A legal document offering securities. Explain offer, terms, issuer, planned use of money, historical F/S, other information that could help an individual decide whether investment is appropriate or not.

Leveraged Recapitalization

A takeover defense in which T pays a large debt-financed cash dividend, increasing the firm's financial leverage in order to deter a takeover attempt

Greenmail

A takeover defense in which T repurchases a large block of its own stock at a premium to end a hostile takeover by those shareholders.

We will need both Accounting and Finance to do Valuation. What Do You Think is the Difference Between Accounting and Finance?

Accounting statements provide the RM for financial analysis. They do not directly provide firm's MV and FCF projections, BUT they are building blocks for any financial forecast or valuation analysis (Looking into rear view mirror) Financiers need info about company's MV and ability to generate cash into the future. F/S of a company do not give this info directly (Looking into the windshield)

Bear Hug

Acquirer mails letter to T's BoD announcing intentions and requiring a quick decision on bid. Bear hug is warm and comfy but you also have to be careful with it.

Dissect Enterprise Value?

All elements come from right-hand side of the B/S (except for excess cash). They are all providers of capital (except for excess cash). - Debt: only interest-bearing debts (no A/Ps...) - P/S - MI: If your company owns > 50% but < 100% of another company, you are required to consolidate 2 F/Ss together. MI = equity you don't own. It's a liability. Why do we subtract excess cash?

What does it mean to say a deal is "accretive" or "dilutive"?

An acquisition is said to be "accretive" if the Acquirer's EPS goes up post-deal; it is "dilutive" if the Acquirer's EPS goes down.

Venture Capital

Capital to finance early (pre-IPO) stages. We have different types of suppliers of venture capital: - Private partnerships/corporations - Large industrial/financial corporations with established venture-capital subsidiaries - Government - Individuals & wealthy families (typically w/ net worth of +1M) - have substantial business experience & can tolerate high risks

Underwriter Spread

Costs depends on type/size of offer. Syndicate have commissions are about 7% in US but around 4% in other countries - Underwriters don't compete on fees apparently

Terminal or perpetuity growth rates can be: (a) greater than the GDP growth rate of the country. (b) lower than inflation. (c) greater than the WACC of the firm. (d) None of the above statements are correct!

D