Studied by 25 people
Organizations need _____________ to be able to buy land, buildings, equipment, and supplies
Resources
The money needed to acquire these \n assets is referred to as the organization’s
Capital
The choices made with respect to obtaining \n resources determine the ________________ of the firm: i.e., their debt-to-equity ratio
Capital Structure
The capital structure of the organization represents the __________________ of the balance sheet: liabilities and stockholders’ equity
right-hand side
The returns must be ______________ of the cost \n of capital used to acquire assets to create \n shareholder value
in excess
Creates internal “______________” for projects \n to clear
hurdle rate
A company’s cost of capital is a function of their
(1) cost of __________ capital \n (2) cost of ________ capital \n (3) capital _______________
Equity
Debt
Structure
The riskier an investment is, the greater the \n _____________ demanded by investors.
Return
For example, a low-risk borrower is likely to be \n able to borrow money at a __________ interest \n rate than would a high-risk borrower.
Lower
Similarly, there is a __________________ trade-off in equity returns.
risk-return
Investments in risky stocks are expected to earn \n ____________ returns than investments in low-risk stocks, and stocks are priced accordingly.
higher
The higher _____________ rate of return is \n compensation for accepting greater uncertainty in returns.
expected
Why? Investors’ demand for greater returns on risky stocks _______________ the company’s expected future returns to a lower present value.
discount
Equity investors’ expected _____________ is \n the cost of equity capital
rate of return
Equity securities are riskier than debt \n securities
Cost of equity capital > Cost of debt capital
Equity holders expect to earn a certain rate of \n return, like debt holders receive interest, and \n this is a real cost that influences __________ \n ____________
managers’ actions
KEY: Equity isn’t “free” money – you must expect to pay back ______________ with “interest” (like w/ debt)
Equity Holders
Disappointing investors makes it harder for the company \n to raise _________________ in the future – and also affects a CEO’s reputation and future career opportunities
More capital
Through _____________ funds
Internal
Through ________________
Creditors
Through equity __________
Investors
The “pecking order hypothesis”
states that firms \n follow this preferred order of financing
Common stock is the ____________ ownership unit in a company
\n primary
Common stockholders:
own a ________________ on the corporation’s assets
\n have the right to vote to elect the board of directors
\n are entitled to a ________________ share of \n distributions (such as dividends)
\n can freely sell their ownership interest
Residual claim;
Proportionate
Common stockholders hope to benefit from \n ______________ and/or increases in the _________ _______________
dividends; value of the stock
Issuing additional shares of stock ___________ the ownership share of all ____________ owners
dilutes; stock
Equity increases your ________________ of capital
cost
Cost of debt is ___________ than cost of equity
lower
Tax benefit of debt \n Interest is tax-deductible, ____________ \n payments are not
dividend
Loss of ___________ with equity \n Common stockholders have perpetual voting \n rights \n Control only transfers to debtors under threat of \n ____________
control; bankruptcy
Equity issuances dilute __________ ownership \n shares
existing
\n Debt increases __________ risk, as debt payments are mandatory
default
\n Debt covenants and/or large amounts of mandatory payments can limit scope of _____________ opportunities
investment
_____________ preference
Dividend
Preferred shareholders receive dividends on their shares before common shareholders
\n ______________ preference
Liquidation
If the company were to fail, funds from assets sold in liquidation go first to pay debtors, next to preferred shareholders, and finally to common stockholders
“Mezzanine” financing (debt-equity _________) \n
Unlike debt, does not increase risk of bankruptcy
Hybrid
\n Call feature: Provides the issuer the right, but not obligation, to repurchase the \n preferred shares at a ___________________
specified price
Conversion feature:
Allows preferred shareholders to convert their shares into common \n shares at their option at a predetermined ____________________
\n Yields a higher price than if not convertible
\n Imposes a cost on common shareholders
conversion ratio
\n Nonvoting shares
Most preferred shares have no voting rights
Give employees the right to purchase shares \n of stock at a ___________________ price
predetermined
Vesting period \n Period of time during which the employee may \n _________________________ the stock option
not exercise
\n Fair value of each stock option grant must be \n recognized as an ______________ on the \n income statement over the vesting period
expense
\n More than half of CEO compensation is now \n comprised of _________________
stock options
Cash dividends
Most are paid quarterly \n Not all companies pay dividends
\n Trend over time towards _____________ over dividends
repurchases
Strong ______________ value
A firm’s stock price substantially increases (decreases) upon the announcement of an increase (decrease) in dividend payout (i.e., when the dividend changes)
What this means: dividend decisions convey information held by the firm’s insiders but not publicly known
signaling
(1) pay a 10% ____________ on common stock or \n (2) use the same amount of cash to _____________ some of its shares. Let’s further imagine that you own 10 shares of stock, and do not have any pressing liquidity needs.
All things equal, do these provide ______________ to you?
Dividend
Repurchase
Equal Value
KEY: Value of cash in hand vs. Value of \n _____________ of an asset
Appreciation
Now let’s say you do have liquidity needs and prefer cash. Are these things still identical? Why isn’t the dividend clearly better?
Yes. You can always __________ 1 share of your stock – providing the same cash as the dividend would have – and your remaining shares 9 shares are as __________ as the 10 shares after a dividend payment.
Equity payouts (____________________ \n to shareholders) come in two forms
Returning Value
Dividends (direct; cash in hand)
Stock repurchases (indirect; appreciation \n in value)
Long-term trend towards ________________
Tax advantages to shareholders in the U.S. \n
Capital gains versus ordinary income \n
Advantages to managers holding stock options
repurchases
Issuing vs. repurchasing equity shares
Companies tend to issue new shares at high prices (which sends a ________________ signal to the market) and repurchase shares at low prices (which sends a _____________ signal)
negative; positive
\n A company buys its ________________ from \n investors at the market price
own stock
Reasons for repurchase:
To ______________ the number of shares outstanding in order to increase stock price (anti-dilutive)
reduce
Reasons for repurchase: Sends a positive signal to the market that management views stock as ___________________ Impact of signal favorably impacts share price
undervalued
To offset the _____________ effects of an employee stock option program
dilutive
\n Stock dividends: additional shares of \n stock _________________ to \n shareholders on a ratable basis
distributed
No effect on the % _____________ by \n each investor
owned
Stock split is similar in ____________ to a \n stock dividend
substance
A typical stock split is 2-for-1:
the company distributes one additional share for each share owned by the stockholders (so no effect on the % owned)
Some evidence of a positive signaling value
signaling
___________________ benefit: makes you feel \n like you have more
psychological
Stock split: reduces stock price to a more \n reasonable ________________, perhaps opens \n up some possible investors
trading range
Note 
Flashcard (24)