Corporate Finance FINAL
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thepenprevails on December 3, 2010
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82 terms
Terms | Definitions |
|---|---|
 WACC | the weighted average of the firm's cost of equity, preferred stock, and after-tax debt is known as |
| adjust, project | If the risk of an investment is different than the firm's risk then you must _____ the discount rate for the project based on the ________ risk |
| systematic | The beta of a security provides an estimate of the __________ risk of the security |
| greater | The beta of the common stock of a levered firm is ________ than the beta of the common stock of an unlevered firm |
| beta | regression analysis can be used to estimate ______ |
| beta, equity | Using the CAPM equation to calculate the cost of capital for a risky project assumes that using a firms ______ is the same measure of risk as the project AND that the firm is all _____ financed |
| systematic, 1 | the ________ risk of the market is measured by a beta of |
| covariance, variance | The beta of a security is calculated by dividing the ________ of the security with the market by the _________ of the market |
| market risk premium | the slope of an asset's security market line is the section of CAPM also know as the |
| MM Proposition II (w/o taxes) | The proposition that the cost of equity is a positive linear function of capital structure is called |
| MM Proposition I w/o taxes | illustrates: (1) The value of an unlevered firm equals that of a levered firm (2) one capital structure is as good as another (3) leverage does not affect the value of the firm, & (4) capital structure changes have no effect on stockholder's welfare |
| MM Proposition I w/ taxes | illustrates how the value of the firm increases as total debt increases b/c of the interest tax shield |
| covariance, market, correlated | Beta measures depend highly on the ___________ of the security with the _________ and how they are ____________ |
| SML, return, risk | A stock with an actual return that lies above the ______ line has yielded a higher ________ than expected for the level of _____ assumed |
| unlevered cost of capital | the cost of capital for a firm with no debt in its capital structure |
| capital structure, increases | A manager should attempt to maximize the value of the firm by changing the _________ __________ if and only if the value of the firm __________ |
| MM Proposition I w/ no tax | The concept of homemade leverage is most associated with |
| direct bankruptcy | The explicit costs, such as legal expenses, associated with corporate default are classified as ______ _________ costs |
| liquidation | The complete termination of a firm as a going business concern is called ____________ |
| technically insolvent | A firm is said to be __________ ___________ when it is unable to meet its financial obligations |
| CML | displays the pricing relationship between the optimal portfolio and the standard deviation of the portfolio |
| internally | The pecking order states how financing should be raised. In order to avoid asymmetric information problems and misinterpretation of whether mgmt. is sending a signal on security overvaluation the firm's first rule is to finance with _________ generated funds |
| lending portfolio | type of portfolio containing risk-free and risky Assets (assets not liablities) |
| borrowing portfolio | type of portfolio involving investment of total capital plus borrowed funds in a risky asset (debt not assets) |
| risk-free | A __________ asset has zero variance and zero covariance with any other asset |
| CML | the line from the risk free rate that is tangent to the efficient frontier is sometimes called the |
| tangency portfolio | the unique portfolio of risky assets that is also on the CML is called the |
| two fund seperation theorum | theorum that states: all investors, regardless of their risk preferences, will form optimal portfolios by combining only two assets; the risk-free asset and the tangency portfolio. The investor chooses the weights of risk-free asset and the tangency portfolio based on his risk preference |
| systematic risk | Also, known as market risk, the risk that cannot be diversified away |
| beta | a measure of how an individual security's returns vary with market returns |
| 1 | the beta of the market portfolio is |
| more, less | A firm with a beta > 1 is ______ volatile than the market. A firm with a beta < 1 is ______ volatile than the market. |
| SML | the graph of the linear CAPM relationship |
| CML, SML | ______ holds for fully diversified portfolios without unsystematic risk, and does not hold for single securities which have idiosyncratic(unsystematic) risk. ______ is different in that it holds for any security and measures systematic risk with beta |
| CAPM, SML | ______ is the equation that puts a specific functional form on the relationship between a firm's beta and its expected return. Predicts that all assets lie on the ____. |
| less, greater | The portfolio expected return is a weighted average of the asset returns, so it must be _____ than the largest asset return and _______ than the smallest asset return |
| standard deviation, less, less | The ________ _________ can be ____ than that of every single asset in the portfolio. However, the portfolio beta cannot be ____ than the smallest beta because it is a weighted average of the individual asset betas |
| cost of equity capital | From the SHAREHOLDER'S perspective, the ______________ is the return they expect to receive |
| problems with cost of equity capital | betas may vary over time, sample size may be inadequate, betas are influenced by changing financial leverage & business risk, and the equity of the firm is not publicly traded |
| solutions to cost of equity problems | beta variation and inadequate sample size can be mitigated by more sophisticated statistical techniques, betas being influenced by changing leverage & business risk can be reduced by adjusting for changes in business & financial risk, and the equity of the firm not being publicly traded can be solved by looking at average beta estimates of comparable firms |
| estimating the cost of capital | (1) estimate equity beta (systematic risk) (2) estimate required ROR on equity, and (3) effects of leverage (results) |
| beta, systematic | The _____ of a security provides an estimate of the _________ risk of the security |
| measurement error | Estimating beta for similar firms can help reduce some of the __________ ______ in beta |
| market risk premium | (Rm-Rf)= |
| beta, project, equity | Using CAPM to calculate the cost of capital for a risky project assumes that using the firm's _____ is the same measure of risk as the ________ AND that the firm is all _______ financed |
| WACC | ______ is used to calculate the cost of capital when a firm uses leverage. |
| ROE, ROA, leverage | Regarding cost of capital, the required _ _ _ will be higher than the required _ _ _ because of the effects of __________ |
| WACC | the required return on assets is also known as |
| WACC | the weighted average of the firm's cost of equity, preferred stock & after-tax debt |
| greater | All other things equal, the beta of the common stock of a levered firm is _______ than the common stock off an unlevered firm |
| value | Regarding capital structure, the sum of the value of the firm's debt and the firm's equity |
| big | A firm should pick the debt-equity ratio that makes the pie as ____ as possible |
| shareholders, increases | Capital structure changes benefit __________ if and only if the value of the firm ________ |
| M&M Proposition I (w/o taxes) | proposition stating that leverage cannot influence firm value, given a levered OR an unlevered firm, the investor can create the other himself (homemade leverage is most applicable here) |
| M&M Proposition II | prop stating that leverage increases the risk and return to stockholders |
| M&M Proposition I (w/o taxes) | prop stating that in a world with no taxes, the firm value is unaffected by capital structure (homemade leverage is most applicable here) |
| M&M Proposition II (w/o taxes) | prop stating that in a world with no taxes, leverage increases the risk and return to stockholders. ***It states that the required return on a firm's equity is positively related to the firm's debt-equity ratio |
| M&M Proposition I | prop stating that the firm value increases with leverage (due to the interest tax shield) |
| homemade leverage | the use of borrowing on the personal level as opposed to the corporate level |
| direct costs | financial distress costs including legal and administrative costs |
| indirect costs | financial distress costs including agency costs as well costs incurred as a result of impaired ability to conduct business |
| selfish strategy # 1 | "take risks" strategy. e.g., suppose bonds are not due today. Manager can gamble with bondholders' money (S/he still controls the assets!) |
| selfish strategy # 2 | "underinvestment" strategy. e.g., stockholders of a firm with significant probability of bankruptcy often find that new investment helps the bondholders at the stockholders expense. In boom times the stockholder would benefit, but in a recession would likely make nothing (bankruptcy.) However, a bondholder wins in both cases without additional investment in either case. |
| selfish strategy # 3 | "milking the property" strategy whereby dividends are liquidated (paid out) and possible increases in perquisites to shareholders and/or mgmt. take place during a period where their is a probability of bankruptcy |
| protective covenants, debt consolidation | Costs of debt can be reduced via _________ _________ and ______ ___________ |
| protective covenants | Limits on dividends, limits on sale of assets, minimum net working capital requirements, and limits on further borrowing are all examples of ___________ ______________ that can be implemented to reduce debt |
| debt consolidation | A way of reducing debt whereby the number of debtor parties is minimized, effectively lowering contracting costs |
| trade-off theory | the theory that capital structure is based on a trade-off between the tax advantage and the costs of financial distress |
| pecking order theory | theory stating that firms prefer to issue debt rather than equity if internal financing is insufficient |
| internal financing, debt, new equity | According to the pecking order theory, ________ ___________ should be used first, followed by ________, and finally by ___ _______ |
| new equity, down, more, overpriced | In the pecking order theory, ____ _______ is issued last because the announcement of stock issue drives the stock price ________ b/c invetors believe managers are ______ likely to issue when shares are __________ |
| debt, equity | According to the pecking order theory, if external financing is required, firms issue _____ first and ______ as a last resort |
| equity, lower | growth implies significant ______ financing, even in a world with low bankruptcy costs. Thus, high-growth firms will have _______ debt-equity ratios than low-growth firms |
| how firms establish capital structure | low debt-asset ratios, changes in financial leverage affect firm's value (stock price increases with leverage and vice-versa), capital structures vary across industries, and firms behave as if they had a target debt-equity ratio |
| factors in target d/e ratio | taxes (highly profitable firms should use more debt), types of assets (distress costs are significant and depend on asset type), uncertainty of operating income (uncertain operating income = greater chance of financial distress, and pecking order & financial slack (firms prefer to issue debt rather than equity if internal financing is insufficient... some slack is probably good) |
| bankruptcy process | business failure, legal bankruptcy, technical insolvency, accounting insolvency, liquidation, and reorganization |
| business failure | when a business has terminated with a loss to creditors |
| legal bankruptcy | when a business has to petition federal court for bankruptcy |
| technical insolvency | when a firm is unable to meet financial/debt obligations |
| accounting insolvency | when a businesses book value of equity is negative |
| liquidation | Ch. 7 of the Federal Bankruptcy Reform Act of 1978, whereby trustee takes over assets, sells them , and distributes the proceeds according to the absolute priority rule. This is the complete termination of a firm as an ongoing business concern |
| reorganization | Ch. 11 of the Federal Bankruptcy Reform Act of 1978, whereby the corporation is restructured with a provision to repay its creditors |
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