Finance 100 study guide

Corporate Financing Decision: 0 NPV transaction (not always 0 NPV, subsidy= pos npv, creating new security)

Efficient Capital Markets: price reflects available info, investors receive fair price when interact, firms get fair price for securities it sells
Pt= Pt-1 + Expected $ return given risk + Random price error

Rt= E(Rt) + Error t (abnormal return, efficient mkt makes unpredictable)
Rt= Rft + B(Rmt – Rft)

Weak: past market info, weak form efficiency, tech analysis will fail
Semi-Strong: all public info, repurch info, semi strong form efficiency, fundamental analysis will fail
Strong: all information, inside info, strong form efficiency

Examine mkt info: can it be used to generate higher return than justified given risk? (abnormal return)

Abnormal Return= Rt – (Rpt + B(Rmt-Rft)) =0?, if +/- mkt is inefficient

Capital Structure: mix of securities (D&E), assume shareholders interests are served by maxing value of firm

Interest = Debt*r
Levered Firm: EPS= Earnings After Interest/#shares bought

Buy unlevered equity and borrow on own account:
With shares of unlev equity, calculate payoff for all outcomes (rec, mod, exp)
Borrow $ at r=10%, calculate interest ($*r)
Find net payoff (payoff-int)
 Homemade leverage, if net cost is $20, levered equity= $20/share

** With perfect competitive market and no taxes, value doesn’t change with capital structure (Vl=Vu)

VL= Vu + TcD – PV of expected costs of financial debt

Costs of financial distress:
Direct Costs
- Legal and administrative
- Empirically costs on avrg are about 3% of value of firm when in bankruptcy >Prob of bankruptcy= 5%, expected costs= (.05)*(3%)= .15%
Indirect Costs
- Impaired ability to do business >Loss of customers, unable to fund business >Estimate of costs 8-20%
- Agency costs >Stockholders control firm and are “agents” for bondholders >When firm is in distress, stockholders may make decisions that do not maximize