ACF Final Exam With Complete Answer.

If we use a single cost of capital to evaluate projects through the organization, what happens to risky and safer projects? - correct answer For riskier projects, you overvalue them and the firm because the risk isn't comparable and vice versa for safer projects When comparing across firms, how can we compare risk? - correct answer We have to use Ra or beta_a of projects with similar assets R_a comparison EQ - correct answer (D/A) x R_d + (E/A) * R_E How does the unlevered value of a firm compare to levered in perfect markets? - correct answer V_l = V_u How does the unlevered value of a firm compare to levered if the only imperfection is taxes? - correct answer V_l = V_u + PV(ITS) [PV(ITS) = t* D if debt is permanent] Valuation Assumptions for using WACC - correct answer 1) The project has average risk so that the WACC of the project = the WACC of the firm 2) Firm's D/E ratio is constant 3) Taxes are the only friction Adjusted Present Value - correct answer Adjusting the unlevered value by the present value of the interest tax shield Valuation Assumptions for using APV - correct answer 1) Discount FCF using R_a 2) Target D/E so the debt level fluctuates with the firm value, which shares the same level of risk as the firm - therefore ITS shares the same risk as the firm 3) Discount ITS by R_a Valuation: WACC VS APV - correct answer WACC: 1) Easy and most common 2) Correct when D/E is stable over time APV: 1) Easier to use when D/E changes over time and you have a constant debt level with the debt repayment schedule 2) More flexible and shows the value of both the project and capital structure decisions Dividend Declaration Date - correct answer The date the board authorizes the dividend Record Date - correct answer All shareholders that have shares on or before record date will receive dividends Ex-dividend date - correct answer Shares purchased on or after ex-dividend date, which is two days before the record date as it takes three days for shares to be registered, won't receive dividend Open Market Repurchases - correct answer Most common form of repurchases (~95%) where the firm repurchases shares in the open market and is not obligated to repurchase the full amount it originally planned Tender Offer - correct answer Firms offer to buy shares at a pre-specified price of about a 10-20% premium during a short time period (~20 days) and if shareholders do not tender enough shares, the firm may cancel the offer Target Repurchase - correct answer Firm purchases shares directly from a major shareholder at a price negotiated directly with the seller When does a target repurchase happen - correct answer When a major shareholder desires to sell a large number of shares but the market for the shares is not liquid to sustain such a large sale without severely affecting the price or in the case of greenmailing Greenmail - correct answer Combination of blackmail and greeback whereby a "greenmailer" buys up a substantial portion of a company's shares and threatens a hostile takeover and the company attempts to resist by repurchasing shares at a premium from the greenmailer Activist Investor - correct answer Shareholders with a large block of stock who seek to influence a company's decisions and strategy How do share repurchases and dividends compare in a perfect capital market - correct answer in a perfect market, open market repurchases have no effect on the stock price and the stock price is the same as the price pre-dividend payment In a perfect capital market, how does changing dividend policy impact the value? - correct answer Assuming the investment policy is fixed, the firm's choice of dividend policy is irrelevant and does not affect the initial share price When dividend tax capital gain tax? - correct answer Shareholders will prefer share repurchases and it is undesirable for firms to raise funds by issuing shares to pay a dividend so the optimal payout policy is zero dividends How do dividends and share repurchases affect equity value and leverage ratio? - correct answer They both lower equity value which increases leverage ratio Given the tax disadvantage of dividends, why are firms still paying them? - correct answer Both approaches create the same financial distress cost and agency costs occur as they both increase the leverage, which can cause debt overhang and risk shifting, and the actions signal different information Signaling Effect of Dividends - correct answer Dividends function similar to debt because they are legally binding Dividend Smoothing - correct answer Managers try to maintain a relatively stable dividend, even though earnings can be volatile and so they increase dividends, only when they perceive a long-term sustainable increase in future earnings, more than they cut