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Intermediate Corporate Finance
Final Exam- info from 4th Exam
Terms in this set (24)
What is business risk?
Uncertainty about future operating Income
Are financing effects included in Business risk?
is the use of FIXED operating costs rather than variable costs, in products total cost
If most operating costs are fixed, then the firm has ______ operating leverage
More operating leverage leads to _____ business risk.
more; a small sales decline causes a big profit decline
Can use operating leverage to get higher _______, but risk increases
What is Financial Leverage?
the use of debt and preferred stock, with fixed financing costs
What is Financial Risk?
the additional risk concentrated on a common stockholders as a result of financial leverage
Business Risk vs. Financial Risk
Business risk depends on business factors such as competition, product liability, and operating leverage.
Financial risk depends ONLY on the types of securities issued: more debt and preferred stock, means more financial risk
How do financial and business risk relate to stand- alone risk of firm?
Stand alone risk = Business risk + Financial risk
High business risk leads to firms probability of financial distress to be higher. What is the end result?
It would be an optimal capital structure with less debt
What does a firm need to do in order to maximize the firms value?
What is dividend policy?
it is the decision about what to do with firm's earnings(net income).
How much to distribute versus how much to reinvest in the firm
What are the 2 main distribution methods
Common Stock repurchases
what are the 3 theories on investors prefering high or low payouts?
Explain Irrelevance Theory
Investors do not care what payout is set
Explain Bird-in-the-hand Theory
Investors prefer a high payout.
Investors think dividends are LESS RISKY than potential future capital gains
Explain Tax preference:
Investors prefer a low payout in order to get growth and capital gains.
RE leads to capital gains, which may be taxed at lower rates than dividends.
This could cause investors to prefer firms with low payouts, i.e. low payout results in a low cost of equity
Modigliani-Miller M&M supported which payout theory?
Irrelevance, but their theory is based on unrealistic assumptions
Explain "signaling" hypothesis
Dividend cuts not well received by investors, so managers won't raise dividends unless increase is sustainable.
Investors view dividend increases as signals of managements positive view of future
Explain "clientele effect"
Different groups of investors, or "clienteles," prefer different policies.
Past dividend policy determines current clientele of investors.
Clientele effects inhibit policy chagnes.
Explain the residual dividend model
Find the retained earnings needed to support the capital budget.
Pay out any leftover earning (the residual) as dividends.
What are stock repurchases?
When a firm buys back its own stock
Reasons for repurchases:
An alternative to cash divs
To dispose of 1 time cash from an asset sale.
To make a large capital structure change
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