Corporate Financial Policy (Raising Capital)

Cost of equity

The return a firm must earn on its equity to satisfy its shareholders.

Security Market Line (SML)

A graphical representation of the Capital Asset Pricing Model (CAPM) which depicts the relationship between systematic risk and expected return.

Weighted Average Cost of Capital (WACC)

A calculation of a firm's cost of capital in which each category of capital is proportionately weighted.

Market risk premium

The additional return expected from holding a risky market portfolio instead of risk-free assets.

Pre-tax cost of debt

The interest rate a company pays on its existing debt before taking taxes into account.

After-tax cost of debt

The actual cost of debt after accounting for the tax deductibility of interest payments.

Venture capital

Financing for new firms which generally entails high levels of risk.

Red Herring

A preliminary prospectus for a security offering that includes important but incomplete information.

Tombstone

Advertisements in a financial newspaper announcing a public offering of securities and listing the investment banks handling the offering.

Seasoned Equity Offering

The sale of newly issued equity shares by a firm that is currently publicly owned.

Underwriter

An entity that buys shares from the issuer and sells them to the public.

Firm Commitment Underwriting

A type of underwriting where the issuer sells the issue to a syndicate, which resells it to the public and assumes the risk of unsold shares.

Shelf Registration

Allows a corporation to register a large issue with the SEC and sell it in small portions, reducing flotation costs.

Green Shoe Provision

Allows the underwriters to purchase additional shares from the issuer in the event of oversubscription.

Lockup Agreements

Restrictions that prevent insiders from selling their shares of an IPO for a specified time period.

Best Efforts Underwriting

An underwriting agreement where the underwriter must make their best effort to sell the securities at an agreed-upon price.

Types of Issuance Costs

spread, other direct expenses, indirect expenses, underpricing, Green Shoe option

Types of long-term debt

Bonds, private issues, term loans, private placements

All else constant, which one of the following will increase a firm's cost of equity if the firm computes that cost using the security market line (CAPM) approach? Assume the firm currently pays an annual dividend of $2.10 a share and has a beta of 1.1.

an increase in the market rate of return

When calculating the weighted average cost of capital (WACC) an adjustment is made for taxes because

interest on debt is tax-deductible, reducing the overall cost of capital.

What best describes the role of taxes on the after-tax cost of
capital in the U.S. from the different capital sources?

Common Equity Preferred equity Debt
A) No effect No effect Decrease

Assume that a company has equal amounts of debt, common stock, and preferred stock. An increase in the corporate tax rate of a firm will cause its weighted average cost of capital (WACC) to:

fall

interest paid on corporate bonds in the US is

tax deductible, so the after-tax cost of debt capital is less than the before-tax cost of debt capital.

Dividend payments are

not tax deductible, so taxes do not decrease the cost of common or preferred equity.

What is an underlying assumption of the dividend growth
model?

A stock's value is equal to the discounted present value of the future cash flows which
it generates.

a decrease in all stock values

based on the dividend growth model, if you expect the market rate of return to increase across the board on all equity securities, then you should also expect:

Early stage financing consists of these 3 parts:

friends & family, angel investors, venture capital

Advantages of Direct listings

cost effective, fast process, liquidity to owners who wish to cash out, no dilution of existing stockholders

Disadvantages of Direct listings

no research analysts, no road shows, no investment banks to help price the stock-less transparency for investors

Types of Long-term Debt

Bonds, Private issues

What are the 2 types of private issues

Term loans, private placements

why does underpricing exist?

to induce more investors to participate in the IPO