Bottom-up Beta formula
BL = Bu*(1+(1-t)(D/E))
%change in EBIT / %change in Revenues
Cost of Equity = Ke
- Riskfree rate + BetaL * (Risk premium)
- Rf + Blevered * (Rm - Rf)
Annual dividends per share / Price per share
Expected Return on Stock-formula
Dividend yield + Price appreciation
Bu = Unlevered Beta = Asset Beta
- Current Beta
- _________________(1+(1+t)(Average D/E)
WACC stands for?
Weighted Average Cost of Capital
Bunlevered * (1+(1-t)(D/E))
Ke*(E/E+D) + Kd*(D/E+D)
(after tax Ke)
BL = Bu * (1+(1-t)(D/E))
What does the Investment Principle say?
Invest in assets that generate more than the minimum acceptable return (hurdle rate).
What does the Financing Principle say?
The mix of Debt and Equity should maximize the value of the investments.
What does the Dividend Principle say?
If firms doesn't find investments that earn their minimum required return (hurdle rate) then the excess cash must be returned to the owners in form of dividends.
What does the Financing Hierarchy look like?
Most preferred first.
- 1. Retained earnings
- 2. Straight debt
- 3. Convertible debt
- 4. Common stock
- 5. Straight preferred stock
- 6. Convertible preferred.
What downsides are there when using Debt?
- 1. Threat of bankruptcy increases with more debt.
- 2. Higher risk in the firm resulting in higher interest rates (agency costs).
- 3. Bond holders can reduce firm's flexibility with bond covenants.
- 4. When general interest rates go up, so does the interest expenses.
What upsides are there with Debt?
- 1. Interest is tax-deductible.
- 2. Increased debt increases discipline to choose good investments to be able to pay interests.
- 3. Leverage on the equity.
Cost of Capital-formula
Ke * (E/E+D) + Kd * (D/E+D)
Cost of Debt-formula
(Rf + spread) * (1-t)
What does high Operating Leverage mean?
You have high fixed costs. When revenues increase, the profit increases relatively more and vice verse.
What does high Financing Leverage mean?
It increases the Equity Beta. High FL equals high interest costs --> profit varies more when revenues vary.
If a firm moves to a tax heaven, how will that affect the Firm Value?
- If High D/E-ratio --> Value decreases as tax shield decreases.
- If low D/E-ratio --> Value increases as tax expenses decreases.
If given WACC, Rf, number of Shares.
How do you estimate firm value?
- Enterprise value = shares / (WACC-Rf)
- Equity = Enterprise value * (E/E+D)
- Value per share = Equity / Shares
What Fundamental Variables influence the Beta?
- 1. Type of business (Cyclical? Discretionary products?)
- 2. Degree of Operating Leverage.
- 3. Degree of Financial Leverage.
Explain the Gordon Growth Formula.
Stock Value (P) = D / (k - G
- D = Dividends
- k = Cost of Equity
- G = Growth
What is included in "Enterprise Value"?
Value of Equity AND Value of Debt.
Interest Coverage Ratio, You divide which result with Interest Expenses?
- Earnings Before Taxes
- (as you get tax deductions on interest expenses).
What's the Reinvestment Rate-formula?
Growth / ROC
where ROC is Return on Capital.
What is the Dividend Payout Ratio-formula?
Dividends / Earnings
What is the Retention Ratio?
- 1-Dividend Payout Ratio
- How much of the earnings are reinvested in the firm.
- Higher tends to lead to higher growth.
What assumptions must hold for "Stock Prize Maximization" to be only objective?
- 1. No opportunistic managers.
- 2. Lenders are protected.
- 3. Managers don't mislead or lie to financial markets.
- 4. No social costs i.e. all cost are transferred to firm.
What is included in the M&A value transfer framework?
Market Price. NPV of perfect information business plan. NPV of oeprating synergies - dissynergies. Market price plus control premium. Value creation or destruction.
Name the six Acquisition types.
- Public to Private (P2P)
- Leveraged Buy Out (LBO)
- Hostile bid (aka Unsolicited)
- Asset deal
Name the 4 Merger types.
- Market value based.
- Contribution based.
- Merger of Equals (MOE)
- Dual headed structure.
What is a merger?
Target firm becomes part of acquiring firm.
What is a Consolidation?
Target and Acquiring firm becomes a new firm.
What is a Tender Offer?
Target firm continues to exist while dissident stockholders hold out. Merges eventually.
What is an Aquisition of Assets?
Target firm remains as a shell but assets are transferred to to acquiring firm. Usually liquidated in the end.
What is a Buyout?
Target firm continues to exist but as a private business.
Why do mergers fail?
- 1. Lack of a Post-Merger Plan to Deliver on Synergy and Control.
- 2. Lack of accountability (Nobody takes responsibility for living up to expectations)
- 3. Culture shock.
- 4. Failure to consider external constraints (Want to lay off people but unions constrain part of plans).
- 5. Managerial egos (Managers from both firms may struggle about power leading to less efficiency).
- 6. The Market Price Hurdle (When bidding wars push up premiums beyond reason).
What incentives are there for M&A?
- 1. Undervalued firm.
- 2. Diversify to reduce risk.
- 3. Create Operating of Financial Synergy.
- 4. Take over poorly managed firms and Change Management.
- 5. Managerial self-interest. (Empire building, Macho-test in bidding wars, new wages after acquisition).
What is FCFE?
- Free Cash Flow to Equity
- Cash left (Net Income) after operating expenses, interest expenses, net debt payments and reinvestment needs.
What is FCFF?
- Free Cash Flow to Firm.
- Cash left (Net Income) after operating expenses, taxes and reinvestment needs BUT before any debt payments.
How can you calculate growth?
(Firm value * Cost of Capital - CF) * (Firm value + CF)
How can shareholders increase their power over management?
- 1. Raise voice on AGM.
- 2. Vote on AGM.
- 3. Demand for better and more updated info.
- 4. Large shareholders becoming part om management.
- 5. Institutional investors take a seat in Nomination Committee.
Why do share prices tend to rise when firms announce increases in dividends?
Credible signal about increasing future cash flows which makes the market adjust its future forecasts.