FINA 365

• investment decision- stocking up inventory ahead of the holiday season
• financing decision- Do we need a bank loan to help buy the inventory?
• investment decision- Should we develop a new software package to manage our inventory?
• investment decision- With a new automated inventory management system, it may be possible to sell off our Birdlip warehouse.
• financing decision- With the savings we make from our new inventory system, it may be possible to increase our dividend.
• financing decision- Alternatively, we can use the savings to repay some of our long-term debt.
• financial asset - a financial instrument that is traded in the financial markets and is intended to be held for investment purposes
• real asset: an asset that has a physical existence and can be touched or seen
• how to maximize current market value: maximize sales maximize profits maximize cash flow maximize shareholder value
• pecking order theory
• financial slack
• asymmetric Information Problems: When one party has more information than the other party, this can lead to inefficient outcomes.
• Agency Problem: The problem of how to allocate scarce resources to achieve the best possible outcome.
• Solutions to agency problems in a firm: monitoring and bonding
• capital structure is the mix of long term and short term debt and equity
• Modigliani and Miller 1958 Proposition 1: The value of the firm is independent of its capital structure (VL=VU)
• M&M 1958 Proposition 2: The return on equity is equal to the return on assets plus a premium for financial risk (RE=RA+(RA-RD)*(D/E))
• M&M 1963 Proposition 1: value of the levered firm increases as debt is added to the capital structure because of the value of the tax shield (VL=VU+T*D)
• M&M 1963 Proposition 2: The return on equity (Re = Ru +(Ru -Rd) P/E *(1 -Tax))
• Trade of Theory of Capital Structure: Theories of capital structure are used to determine the optimal capital structure for a firm.
• suboptimal investment decisions are those that do not maximize the expected value of the firm's future cash flows
• M&M 1961: Dividend Policy is irrelevant X +F = D+ I
• Realities in favor of Lower Dividends: Lower dividends are more likely to be paid out in the form of stock repurchases, which can increase stockholder value.
• plowback ratio: the ratio of the amount of money returned to investors to the amount of money invested
• homemade dividends are dividends paid by a company to its shareholders.
• assumptions in Modigliani and Miller theories: capital markets are efficient, firms are rational, and there is no taxation
• levered firm: a firm that is owned by a single individual or a small group of individuals
• unlevered firm value: firm value without debt
• after-tax cost of debt (rd): the cost of borrowing funds after taking into account any tax savings resulting from interest payments
• cost of equity (r): the expected return required by an investor who holds common stocks
• tax shield: the benefit from deducting interest expense on corporate bonds from taxes owed
• cost of equity (rE'): the required rate of return demanded by investors who own common shares
• before-tax cost of equity (rE): the expected return on an investment in common stock
• accounting break-even point formula: Total fixed costs / (sales revenue - variable costs)