Corporate Issuers

What does Dividend Irrelevance Theory assume?

No transaction costs & No taxes

What is dividend irrelevance theory (Miller and Modigliani)

Dividend policy has no effect on cost of capital or shareholder wealth

What is the practical argument against dividend irrelevance theory on costs?

Buying/selling shares incur transaction costs; dividends do not

What is the practical argument against dividend irrelevance theory on volatility?

Volatility of share price makes ‘homemade dividends’ complicated

What is the practical argument against dividend irrelevance theory on fractional shares?

Shareholders typically cannot purchase/sell fractional shares

What’s the Bird-in-the-hand argument?

Investors prefer dividends over potential capital gains

What’s the counterargument on the Bird-in-the-hand argument?

Paying dividends has no impact to risk of future cash flows. Cash dividends only lowers ex-dividend price of the share. Overall shareholder wealth in unchanged

What’s the dividends tax argument theory?

Investors prefer companies to reinvest earnings in countries where dividend tax rates > capital gains tax rates

What are the characteristics of companies that consistently increase their dividends?

Dominant, niche positions in industry

Global operations

Rleatively high ROA

Relatively low debt ratios

Empirical evidence shows on agency issues that give more funds, managers tend to:

Overinvest, investing in projects that increase company’s size but reduce shareholder wealth

What’s a good way to contrain managements ability to overinvest?

Paying dividends

How do bondholders react to dividends?

Tends to be negative as ability to pay debt is reduced

How do bondholders restrict dividends?

Bond covenants that limits total distribution or restricts dividend payments

How does having more available +NPV investment opportunities effect dividends?

Dividend payout would decrease, increasing retention rate and growth

How does having less available +NPV investment opportunities effect dividends?

Dividend payout would increase, decreasing retention rate and growth

how does industry impact dividend decisions?

Industries that change rapidly, for example technology, require quicker response to changes lowering dividend payments. Conversely, industries like utilities, change gradually enabling higher dividend payments

How does long-term volatility effect dividends?

Companies with high earnings volatility are more cautious about size, frequency of dividend increases

in terms of dividend policy, what do companies that want to increase their financial flexibility prefer ?

They prefer share repurchases to cash dividends

Why is potential tax advantages an argument in favour of share repurchases?

If the tax on capital gains is less then the tax on dividends then share repurchases would maximise after tax returns

Why is share price support an argument in favour of share repurchases?

If the stock price is undervalued, then it makes a good idea to increase the returns (or they might be trying to get the public to buy it)

Why is added managerial flexibility an argument in favour of share repurchases?

No expectations repo will continue

Why is exercise of employee stock options an argument in favour of share repurchases?

Offsets earnings dilution from exercises of employee stock options

Why is financial leverage an arguments in favour of share repurchases?

because it will increase financial leverage so long as ROA > After tax cost of Debt

Why is EPS an argument in favour of share repurchases?

Repurchases increase EPS, so long as ROE > after tax cost of debt

What is the counter argument against share repurchases to increase EPS??

Even though EPS may increase, required return will also increase (Because of higher leverage)

Do repurchases go up or down when the economy is strong or during a recession?

Rises when strong and falls during recessions

When are dividends considered safer?

When the history is stable, although unforeseen circumstances may lead to cuts or omissions

What’s a dividend imputation tax system?

Dividends are effectively taxed once

What happens in the dividend imputation tax system when the investors marginal tax rate is lower than corporate tax rate?

Investor receives a franking credit for taxes paid by the company

What happens in the dividend imputation tax system when the investors marginal tax rate is higher than corporate tax rate?

Investors pays additional taxes so that the total taxes paid correspond to investors marginal tax rate

What’s the split-rate tax system?

Distributed corporate earnings are taxed at a lower rate than retained earnings, distributed earnings are still taxed twice but at a lower net rate

What’s the impact on EPS if ROE < After tax cost of debt?

Decreases EPS

What’s the impact on EPS if ROE > After tax cost of debt?

Increases EPS

What’s the clientele effect?

Unique groups of investors are attracted to companies with specific payout policies

Why might an investor view dividend initiations negatively?

Because it might be signalling a company’s transition from growth to mature stage (implying fewer investment opportunities and slower growth)

What is the impact on likely dividend distribution with high or increasing flotation costs?

Decreases

What is the impact on likely dividend distribution with low or decreasing flotation costs?

Increases

When concerned about competing uses of cash within a company, what dividend coverage ratio would you use?

Comprehensive, meaning FCFE rather than Net Income

What’s the impact on Debt-to-Assets ratio if a company uses cash on hand to initiatie a dividend?

Cash is classified as assets, debt would be unchanged, and assest would decrease, the ratio would increase

Empirical evidence suggests that, within developed markets, the fraction of companies paying cash dividends has

Declined over time

Empirical evidence suggests that, within developed markets, the fraction of companies repurchasing shares has

Increased over time

What’s open market purchases?

Company purchases shares from shareholders on open market

What’s fixed-price tender offer?

Company offers to purchase fixed number of shares at fixed price

What’s dutch auction

Company specifies range of prices and picks lowest price at which it can repurchase desired number of shares

What’s direct negotiation

Company purchases directly from major shareholder

What’s the difference between fixed price tender offers and dutch auctions?

Whilst both can be executed quickly, dutch auctions allow the company to discover whether it could have repurchases shares at a lower price

What are the attributes of open market purchases?

Maximum flexibility, can last for years, cost effective, may require shareholder approval

What are the attributes of Direct negotiation?

Keep off open market, prevent activist investor, provide liquidity to large shareholder in need

What does a share repurchase actually do?

Reduced the number of shares outstanding

Dividend pay,ents are viewed as a way to alleviate agency conflicts between whom?

Shareholders and managers, because the shareholder rely on managers acting in their best interests, and the act of distributing dividends reduced the funds that management has available to invest in potentially negative NPV projects.

What’s the impact on shareholder wealth when a company decides to do a stock dividends?

Individual wleath will not change, each shareholder will own a greater number of shares but now at a proportionally lower price

What are the three types of ownership structures ability to exercise control?

Concentrated, Hybrid, Dispersed

What are company filings, news reports, industry and labor associations, and industry experts all examples of?

Proprietary information as sources for identifying relevant ESG factors

What is MSCI and Susntainalytics both examples of?

ESG data providers as sources for identifying relevant ESG factors

What is the IIRC, GRI, SASB, 2DII examples of?

Not-for-profits s sources for identifying relevant ESG factors

Does callability security features benefit the company (issuer) or investor?

Company (issuer), because it allows the borrower to retire debt early to refinance at lower rates (increases WACC)

Does putability security features benefit the company (issuer) or investor?

investor, because it allows the lender to retire debt early and reinvest proceeds at higher rates (decreases WACC)

Does convertability security features benefit the company (issuer) or investor?

investor, beacuse it allows the lender to convert debt into common shares (decreases WACC)

Does cumulative preferred stock security features benefit the company (issuer) or investor?

investor, because it entitles preferred shareholderes to receive dividend in arrears before common shareholders get paid (decreases WACC)

Does share class security features benefit the company (issuer) or investor?

investors, because it entitles certain shareholders to more voting rights (decreased WACC for superior class)

What’s the only security feature that benefits company (issuer), thereby increasing the WACC?

Callability security feature

What is publically traded debt, with no embedded options also known as?

Straight debt

How to find cost of debt for traded debt (Straight debt)

Use the company’s current market rates for similar debt (similar characteristics, especially maturity) as a proxy for the cost of debt

How to identify the cost of debt for non-traded debt?

matrix pricing based on yields to maturity of bonds of other companies with similar or same maturity and credit ratings

how to estimate the cost of debt/borrowing for bank debt?

Reference recent borrowing rates

What’s sovereign risk?

Covers the risk of a country defaulting on its debt obligations

What’s country risk?

Covers the downside of a country’s business environment including legal environment, levels of corruption, and socioeconomic variables such as income disparity

What is the Equity Risk Premium (ERP)

expected return investors requires in excess of r_f rate

What are the two appraches for ERP?

Historical (ex-post), and Forward-looking (ex-ante)

What are the 4 steps/choices for the historical approach to ERP estimation?

Index selection, time horizon, mean, R_f proxy

What is the survery based approach to forward looking ERP Estimation?

Ask experts what they expect ERP to be

What does survey trend data tend to tell us about ERP estimation?

Higher ERPs for developed countries

What is the Recency Bias

Estimates for Forward looking ERP estimation in Survey approach tend to be sensitive to recent market returns

What is the Confirmation Bias

Estimates for Forward looking ERP estimation in Survey approach tend to pay attention to factors that support current thinking

For calculating ERP, when do you use Arithmetic vs Geometric?

Arithmetic for single period models, geometric for multi-period

For calculating ERP, when do you use Shorter vs Longer Periods?

Longer for providing more information, Shorter for stationarity of risk premium is more likely

For calculating ERP, when do you use short vs long term bonds for a proxy of risk free return?

Short when discounting one year cash flows, long with discounting multiple periods

Can the ratings for a compan’y bonds differ from the company’s corporate debt rating?

Yes, the discrepancy is often the case when the securities offer different levels of seniority, collateral, covenants, or other features

Can the coupon rate of a company’s long-term straight debt provide a reasonable measure of a company’s cost of debt?

No, it is the YTM that provides a reasonable measure

What’s BYPRP?

Bond Yield Plus Risk Premium Approach: R_e = R_d + RP

When is Global CAPM appropriate?

For developed markets: Model inherently assumes universal equity market risk

When is International CAPM appropriate?

For developed markets: Markets that are well connected to the global economy

When is country spread appropriate?

Emerging market countries with established bond markets

When is Damodaran model appropriate?

Emerging market countries with both historical bond and equity return data

What model is used for developed markets: Model inherently assumes universal equity market risk

Global CAPM

What model is used for developed markets: Markets that are well connected to the global economy

International CAPM

What model is used for Emerging market countries with established bond markets

Country Spread

What model is used for Emerging market countries with both historical bond and equity return data

Damodaran model

How dies the Sovereign Yield Spread and Damodaran Country Risk Rating Models differ?

Both use Sovereign Yield Spread as the Country Risk Premium but Damodaran takes it a step further by multuplying it by:
(Volatility of local country’s equity market / Volatility of local country’s bond market)

Describe the Equity Investment action

Minority investment (<50% ownership), where the company acquires influence but not full control. Investee remains independent

Describe the Joint Venture Investment action

Shared control over joint venture, new JV company is a separate legal entity

Describe the Acquisition Investment action

>50% ownership, full control over investee and investee becomes a subsidiary

What’s a horizontal merger

Companies are in the same business (usually competitiors)

What is a vertical merger

Companies are in the same production chain

What is a conglomerate merger

Target business is unrelated to acquirer’s

Who is usually involved with a reorganisiation restructuring process?

Court-led involving all stakeholders

What are the sources of the initial valuation?

Press releases, securities filings, transcripts etc

How does the market perception of restructuring impact share price?

If it will improve value to shareholders then it will provide share price and vice-versa

What happens after the initial evaluation?

Preliminary evaluation

does the initial or preliminary evaluation come first?

initial