Corporate Finance | Guide Exam
Questions and Correct Answers
Capital Asset Pricing Model (CAPM)
a model that relates the required rate of return on a security to its systematic risk as
measured by beta
call option
the option to buy shares of stock at a specified time in the future
put option
the option to sell shares of stock at a specified time in the future
Cash Conversion Cycle (CCC)
the length of time funds are tied up in working capital, or the length of time between paying
for working capital and collecting cash from the sale of the working capital
Return on Equity (ROE)
Net Income/Total Equity
Weighted Average Cost of Capital (WACC)
the weighted average of the cost of equity and the aftertax cost of debt
Why is Equity more expensive than Debt?
Because it comes w/ higher expected rate of return due to higher risk (residual claimant of the
firm's cash flows)
Levered Beta
,The unlevered beta adjusted for financial risk due to leverage
Unlevered Beta
The firm's beta coefficient if it has no debt
working capital requirement
(Current assets - inventory) - current liabilities
Net Present Value (NPV)
the sum of the present values of expected future cash flows from an investment, minus the cost
of that investment
Internal Rate of Return (IRR)
the discount rate that makes the NPV of an investment zero
How do we value a share of stock?
Collapse future earnings down to present value equivalents
Disintermediation
the long-term trend of moving away from banks to markets for capital requirements
Risk-free rate
No such thing...but many use 10 year Treasury bonds as a proxy for the risk-free rate
Flotation Costs
the transaction cost incurred when a firm raises funds by issuing a particular type of security
Flotation Cost Adjustment
the amount that must be added to cost of retained earnings to account for flotation costs
to find cost of new common stock
pure play method
,a method for estimating a project's or division's beta that attempts to identify publicly
traded firms engaged solely in the same business as the project or division
Accounting Beta Method for Estimating Beta
Run regression between project's ROA and S&P Index ROA.
Accounting betas are correlated (0.5 - 0.6) with market betas.
But normally can't get data on new projects' ROAs before the capital budgeting decision
has been made.
effective rate of interest
the annual rate of return that is actually earned (or charged) during the period the funds
are held (or borrowed) k=compounding periods
Special Purpose Vehicle
A legal entity to which the assets used as collateral in an ABS issue are sold. This
transaction separates the assets backing the ABS from the other assets of the company
that creates the SPV.
horizontal merger
the combination of two or more firms competing in the same market with the same good or
service
vertical merger
the combination of two or more firms involved in different stages of producing the same good
or service
conglomerate merger
the joining of firms in completely unrelated industries
congeneric merger
, A merger of firms in the same general industry, but for which no customer or
supplier relationship exists.
hostile takeover
the acquisition of a company over the opposition of its management
friendly takeover
An acquisition in which the management of the acquired company welcomes the firm's buyout
by another company.
The Williams Act
is 1) designed to regulate the conduct of those attempting to take over a company & 2) force
acquiring firms to disclose more info about their offers
Free Cash Flow to Equity
Cash flow that would be available for distribution to common shareholders;
= Cash Flow from Operations (FCF) - Interest Expense _ Interest tax shield + Debt Issued -
Debt Repaid
pure financial merger
No operating synergies are expected, so incremental post-merger cash flows are just target
firm's expected cash flows
operating merger
A merger in which the operations of the firms involved are integrated in hope of
achieving synergistic benefits.
Value of a firm's operations
Present value of a firm's expected FCF's discounted at its WACC
Business Risk
Questions and Correct Answers
Capital Asset Pricing Model (CAPM)
a model that relates the required rate of return on a security to its systematic risk as
measured by beta
call option
the option to buy shares of stock at a specified time in the future
put option
the option to sell shares of stock at a specified time in the future
Cash Conversion Cycle (CCC)
the length of time funds are tied up in working capital, or the length of time between paying
for working capital and collecting cash from the sale of the working capital
Return on Equity (ROE)
Net Income/Total Equity
Weighted Average Cost of Capital (WACC)
the weighted average of the cost of equity and the aftertax cost of debt
Why is Equity more expensive than Debt?
Because it comes w/ higher expected rate of return due to higher risk (residual claimant of the
firm's cash flows)
Levered Beta
,The unlevered beta adjusted for financial risk due to leverage
Unlevered Beta
The firm's beta coefficient if it has no debt
working capital requirement
(Current assets - inventory) - current liabilities
Net Present Value (NPV)
the sum of the present values of expected future cash flows from an investment, minus the cost
of that investment
Internal Rate of Return (IRR)
the discount rate that makes the NPV of an investment zero
How do we value a share of stock?
Collapse future earnings down to present value equivalents
Disintermediation
the long-term trend of moving away from banks to markets for capital requirements
Risk-free rate
No such thing...but many use 10 year Treasury bonds as a proxy for the risk-free rate
Flotation Costs
the transaction cost incurred when a firm raises funds by issuing a particular type of security
Flotation Cost Adjustment
the amount that must be added to cost of retained earnings to account for flotation costs
to find cost of new common stock
pure play method
,a method for estimating a project's or division's beta that attempts to identify publicly
traded firms engaged solely in the same business as the project or division
Accounting Beta Method for Estimating Beta
Run regression between project's ROA and S&P Index ROA.
Accounting betas are correlated (0.5 - 0.6) with market betas.
But normally can't get data on new projects' ROAs before the capital budgeting decision
has been made.
effective rate of interest
the annual rate of return that is actually earned (or charged) during the period the funds
are held (or borrowed) k=compounding periods
Special Purpose Vehicle
A legal entity to which the assets used as collateral in an ABS issue are sold. This
transaction separates the assets backing the ABS from the other assets of the company
that creates the SPV.
horizontal merger
the combination of two or more firms competing in the same market with the same good or
service
vertical merger
the combination of two or more firms involved in different stages of producing the same good
or service
conglomerate merger
the joining of firms in completely unrelated industries
congeneric merger
, A merger of firms in the same general industry, but for which no customer or
supplier relationship exists.
hostile takeover
the acquisition of a company over the opposition of its management
friendly takeover
An acquisition in which the management of the acquired company welcomes the firm's buyout
by another company.
The Williams Act
is 1) designed to regulate the conduct of those attempting to take over a company & 2) force
acquiring firms to disclose more info about their offers
Free Cash Flow to Equity
Cash flow that would be available for distribution to common shareholders;
= Cash Flow from Operations (FCF) - Interest Expense _ Interest tax shield + Debt Issued -
Debt Repaid
pure financial merger
No operating synergies are expected, so incremental post-merger cash flows are just target
firm's expected cash flows
operating merger
A merger in which the operations of the firms involved are integrated in hope of
achieving synergistic benefits.
Value of a firm's operations
Present value of a firm's expected FCF's discounted at its WACC
Business Risk
