FIN 3120 1st Edition Exam #3 Study GuideChapter 15: Dividend Policy- Dividend policy determines the amount of earnings that are distributed to common shareholders vs. being reinvested in the firm.- Determinants of Dividend Policies:o Industry variationso Legal constraintso Restrictive covenantso Tax considerationso Liquidity and Cash Flow considerationso Borrowing capacity & access to capital marketso Earnings stabilityo Growth prospectso Inflationo Shareholder preferenceo Protection against dilution- Irrelevant Dividends theory - o Modigliani and Miller (M&M)o Dividends are irrelevant to firm valueo Assumptions No tax No transaction costs No issuance costs Fixed investment policyo Believes informational content surrounding dividends has more affect on share prices than dividends themselves- Relevant Dividends theory – o Assumptions: Taxes Transaction costs Issuance costso Believes share prices will be affected by the difference between earnings and dividends- Other Factors:o Risk & Risk Aversiono Taxeso Issuance Costso Agency Costs- Commonly Practiced Dividend Policies:o Passive Residual Policy –  The firm should retain its earnings as long as it has investment opportunities that promise higher rates of return than the required rate of return Allows dividends to fluctuate Growth firms will have low dividend payouts under this policyo Stable Dollar Policy –  Reluctant to reduce dividends Dividend increases can lag earnings Desirable to investors- Reliable dividend payouts- Legally desirable investments for other firmso Constant Payout Ratio Policy – Pays a constant percentage of earnings Allows payouts to fluctuate based on firm performanceo Small Regular Dividends + Policy –  Dependable for shareholders Allows for fluctuations with firm performanceo Dividend Reinvestment Plan –  Option for shareholders to reinvest cash dividends into additional shares Comes with income tax liability for dividend earnings even though shareholders don’t receive casho Stock Dividends –  Accounting: Transfer from RE to other stockholder’s equity account. Market price of common stock should decline in proportion to the # of new shares issued May result in an effective increase in cash dividends  Reduction in share price may broaden the appeal of the stock to potential investorsChapter 19: Leasing & Intermediate Term Financing- Operating Leaseo Short term leases For the lessor, typically requires leasing an asset several times to profit Not fully amortizedo Typically cancellable with notice to the lessoro Lessor is typically responsible for costs of owning- Financial/Capital Leaseso Long term leases Lessor’s goal is to recover the asset’s value in 1 lease Fully amortizingo Non-cancellable contractso Lessee is responsible for operating costs- Sale & Leaseback- Direct Leaseso Accounts for almost all leases- Leveraged Leaseso Provide financing for assets that require large capital outlays and have economic lives of 5 years or moreo Tax leveragedo Three party leases: lessor, lessee, and lenderso Only for exceptionally expensive, long lived items (ex. Company jet)- Term Loanso Intermediate term credit (1-10 year maturity)o Used for financing small additions to PP&E- Determining Lease Paymentso Step 1: Compute the lessor’s amount to be amortized Initial outlay Less: PV of after-tax salvage Less: PV of depreciation tax shelter Equals: Amount to be amortizedo Step 2: Compute after-tax lease income required Amount to be amortized = PV of after-tax lease paymento Step 3: Compute before-tax lease payment Lease PMT = After-tax lease income required / (1 - lessor’s MTR) (on formula sheet)Chapter 20: Financing with Derivatives- Derivative: a financial security which derives its value from an another (underlying) asset- Types – o Options The right to buy (call) or sell (put) an asset at a specified price on or before an expiration date- Specified price can also be referred to as an exercise or strike price American option: can be exercised at any point during the period European option: can only be exercised on the expiration date. There is an inverse relationship between calls and puts; both options cannot be in the money at the same time (if they are equal the are at the money) Options do not have to be exercised – the lowest value of an option is 0 Black-Scholes Option Pricing Assumptions –- The stock underlying the call option provides no dividends during the call option’s life.- There are no transactions costs for the sale/purchase of either the stock or the option.- rf is known and constant during the option’s life.o Future/Forward Contracts Commodity futures Financial futures- Based on financial assets or indices Futures contracts must be fulfilled; does involve some level of risko Swaps Involves the exchange of cash payment obligations between two parties, usually because each party prefers the terms of the other’s debt contract.  Reduces financial risko Convertible Securities Conversion Ratio – - Number of shares obtained in conversion = (par value of security / conversion price) Conversion Premium- Conversion price – stock value  Conversion Price = the effective price investors pay for the common stock when conversion occurs Conversion Value = stock price * conversion ration Market Value is the greater of the Conversion Value or Straight Bond Value + Time Value- Subject to ceiling set by call value- Warrantso Function like call options, but last significantly longero Allow investors to participate in common stock performanceo Generally issued with debt, but can be traded separatelyo Can decrease WACC Lower coupon rate- Rights Offeringso Method for raising additional equityo Can be tradedChapter 23: Mergers, LBOs, and Restructurings- Economic Benefits – o Synergy: value of the whole exceeds sum of the parts.o Break-up value: assets would be more valuable if broken up and sold to other companies.- Mergero Friendly vs. Hostileo Verticalo Horizontalo Conglomerateo Stock Mergerso Defense Mechanisms: White Knight Greenmail Supermajority voting requirements Classified board structure Blank check preferred stock Poison pill Standstill agreements Pacman defenseo Shareholders gain the majority of the value of mergers-)(212,121ERNSNSEATEATEATEPSC- Acquisition- Joint