Finance 100 study guide

Topics: Finance, Bond, Stock market Pages: 7 (1239 words) Published: February 26, 2014
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 value of firm  cost

When firm is in financial distress, equity holders want risky projects -May reject positive NPV (if safe) and accept neg NPV (if risky)

Equity holders milk firm of its value- pay divs and extract perks bondholders need protection bond covenants

Tradeoff Theory of Capital Structure: managers choose level of debt to max value of firm tradeoff benefits (Debt tax shield) vs. cost (PV exp cost of distress) -observed debt levels too low for tradeoff theory to be complete explanation

Alternative Theory= Pecking Order Theory
- Ordering of preferred sources of capital
- At any point in time most preferred available source is used - Sources most to least preferred:
>Internal financing
>Debt financing
>Equity financing (assym info)

Implications: no target debt to equity ratio, highly profitable firms will tend to have low levels of debt

Growth & Leverage- maximize value of firm for debt and equity holders by minimizing govt’s share

Assume r=rd=re

Case 1: No growth  Vl=10k, D=10k, 100% Debt, EBIT=interest so that tax inc=0 EBIT
Interest
Taxable Income (=EBIT-Int)
Debt (=interest/r)
Flow to Stakeholders (=Debt*r)

Case 2: EBIT growth @ 5% /yr (growing perp)
If EBIT1= 1000, Debt= 10,000, Time 0 VL= 1000/.10-.05= 20,000, D/VL=.5 50% Debt 50% Equity payments to equity is a new debt growing at 5%/yr, E=500/.10-.05= 10,000

**In general, D/VL=(r-g)/r

Personal Taxes: offset benefits of corp taxes, choose corp structure to max value of firm given ALL taxes

Tc= corp tax rate (35%)
Tp= personal tax rate on int inc (40%)
Tpe= effective personal tax rate on equity income (div&cap gains= 15%) EAT= earnings after taxes

Example:
Operating Income= 100
Interest: Dividend
Corp taxes 0 Tc*100
EAT 100 100(1-Tc)
Personal Tax Tp*100 100(1-Tc)Tpe
Inc after tax 100(1-Tp) 100(1-Tc)(1-Tpe)

Corp tax advantage of debt: CTAD=...
Continue Reading

Please join StudyMode to read the full document

You May Also Find These Documents Helpful

  • Essay about Finance final study guide
  • Finance 100
  • Essay on Finance 300 Study Guide
  • Finance 3000 study guide Essay
  • Study Guide: Corporate Finance Essay
  • Essay about Corporate Finance Study Guide
  • Study guide Essay
  • Corporate finance case study Essay

Become a StudyMode Member

Sign Up - It's Free