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Questions and Answers
What is the main objective of Corporate Finance?
What is the main objective of Corporate Finance?
Maximize the value of the business (firm)
What are the three key decision areas in Corporate Finance?
What are the three key decision areas in Corporate Finance?
What are some of the key aspects of the "Pursuit" in Howard Stevenson's definition of Entrepreneurship?
What are some of the key aspects of the "Pursuit" in Howard Stevenson's definition of Entrepreneurship?
Which of the following is NOT a key aspect of Howard Stevenson's definition of Entrepreneurship?
Which of the following is NOT a key aspect of Howard Stevenson's definition of Entrepreneurship?
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Which type of Entrepreneurial Firm brings new products and services to the market?
Which type of Entrepreneurial Firm brings new products and services to the market?
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What is the name of the scale used to assess the "familyness" of a potential family business?
What is the name of the scale used to assess the "familyness" of a potential family business?
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Which subscale of the F-PEC Scale is most relevant to assess "familyness" in Family Business Finance?
Which subscale of the F-PEC Scale is most relevant to assess "familyness" in Family Business Finance?
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In the context of Family Businesses, what are some of the key characteristics that impact financing decisions?
In the context of Family Businesses, what are some of the key characteristics that impact financing decisions?
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What are the two main types of Family Businesses?
What are the two main types of Family Businesses?
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The Modigliani/Miller theorem (MM) asserts that a company's market value is independent of its capital structure in a world without taxes and bankruptcy costs.
The Modigliani/Miller theorem (MM) asserts that a company's market value is independent of its capital structure in a world without taxes and bankruptcy costs.
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What is the formula for calculating the average cost of capital (ra) in Modigliani/Miller Theorem?
What is the formula for calculating the average cost of capital (ra) in Modigliani/Miller Theorem?
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What are the two core propositions of Modigliani/Miller Theorem?
What are the two core propositions of Modigliani/Miller Theorem?
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In the context of Modigliani/Miller Theorem, the presence of taxes makes the leverage effect more pronounced.
In the context of Modigliani/Miller Theorem, the presence of taxes makes the leverage effect more pronounced.
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The "Trade-off Theory" asserts that a company's capital structure is driven by the trade-off between the benefits of debt finance (tax shield) and the costs of debt finance (expected costs of financial distress).
The "Trade-off Theory" asserts that a company's capital structure is driven by the trade-off between the benefits of debt finance (tax shield) and the costs of debt finance (expected costs of financial distress).
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Explain the concept of "Pecking Order Theory" in the context of capital structure.
Explain the concept of "Pecking Order Theory" in the context of capital structure.
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What are the major findings of the empirical evidence on dividend policy?
What are the major findings of the empirical evidence on dividend policy?
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Which of the following is NOT a stylized fact regarding dividends and share repurchases?
Which of the following is NOT a stylized fact regarding dividends and share repurchases?
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What are the two key forms of payout to shareholders?
What are the two key forms of payout to shareholders?
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Which of the following theories suggests that investors are indifferent to dividend payouts?
Which of the following theories suggests that investors are indifferent to dividend payouts?
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The "Bird in the Hand Theory" suggests that investors prefer certain cash dividends over potentially uncertain stock appreciation.
The "Bird in the Hand Theory" suggests that investors prefer certain cash dividends over potentially uncertain stock appreciation.
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The "Tax Effects Theory" asserts that dividend payout preferences are influenced by tax differences between dividends and capital gains.
The "Tax Effects Theory" asserts that dividend payout preferences are influenced by tax differences between dividends and capital gains.
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Which of the following best describes the "Signaling Theory" of dividend policy?
Which of the following best describes the "Signaling Theory" of dividend policy?
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The "Signaling Theory" asserts that share buybacks are an effective way for firms to signal profitability to the market.
The "Signaling Theory" asserts that share buybacks are an effective way for firms to signal profitability to the market.
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What is the primary reason for the "EPS Illusion" in the context of share repurchases?
What is the primary reason for the "EPS Illusion" in the context of share repurchases?
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A firm's EPS (Earnings Per Share) is likely to increase after share repurchases, even without any improvement in the firm's operational performance.
A firm's EPS (Earnings Per Share) is likely to increase after share repurchases, even without any improvement in the firm's operational performance.
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Study Notes
Introduction to Corporate & Entrepreneurial Finance (MSc Banking & Finance PiE)
- This course introduces the fundamentals of corporate and entrepreneurial finance, focusing on the MSc Banking & Finance programme.
- The lecturer is Prof. Dr. Mehdi Mostowfi, available at [email protected].
- The course aims to build competence and cross borders in the field of corporate finance.
Course Agenda
- Course Outline and Assessment: Initial overview of the course structure and evaluation methods.
- Corporate Finance, Entrepreneurial and Family Business Finance: A deeper look into the financial aspects of these business types.
- Traditional Capital Structure Theory: Examine the theoretical underpinnings of capital structure decisions.
- Payout/Dividend Policy: Explore the options and implications of distributing profits to shareholders.
- Exercises (Homework): Practical application of the concepts through assignments and problem sets.
Main Questions Addressed by the Course
- How is the optimal capital structure determined, and does family ownership influence these decisions?
- How do businesses, especially entrepreneurial ones, raise capital and go public?
- How do mergers and acquisitions work and how are companies valued?
- How are leveraged buyouts (LBOs) structured and used as a valuation method?
Assessment
- Group Presentation (25%): Presentations summarizing research methodology, data, and empirical results (especially in the context of family business capital structure). These presentations critically assess the aspects of the methodology, and how the results support or conflict with traditional capital structure theories.
- Final Exam (75%): Comprehensive assessment of the course's content and concepts.
Content and Learning Objectives (Session 1&2)
- Course Outline: Detailed structure of the course.
- Course Assessment: Methods used to gauge student learning and course effectiveness.
- Definition and Characteristics of Entrepreneurial and Family Businesses: Identifying core differentiators.
- Traditional Capital Structure Theory and Dividend/Payout Policy: Covering the theoretical underpinnings of how companies finance themselves, and how they distribute financial rewards.
- Relevance and Limitations of Capital Structure Theory for Family Businesses: How suitable these models are in the specific case of family businesses.
Recommended Literature
- Brealey, Myers & Allen: Principles of Corporate Finance (14th edition, chapters 17 and 18)
- Graham & Leary: A Review of Empirical Capital Structure Research and Directions for the Future (2011, from the Annual Review of Financial Economics, volume 3, pages 309-345)
The Objective of Corporate Finance and Key Decision Areas
- Maximizing the value of the business (firm) is central to corporate finance
- Investment Decisions: Investing in assets that yield a return greater than the minimum acceptable hurdle rate.
- Financing Decisions: Determining the right mix of debt and equity to fund operations.
- Dividend Decisions: Returning excess cash to shareholders when investments do not meet thresholds.
The Object of Corporate Finance
- A holistic view of the corporation's interaction with financial markets (external) and its internal operations.
- CEO/BoD: Internal reporting is key here.
- Financial Manager: Handling funding, returns, and external reporting.
- Banks: Managing loans and financial advice.
- Financial Markets: Where companies trade and access capital.
- Other Stakeholders: Customers, suppliers, community, and more, who provide support and affect the firm.
Entrepreneurial and Family Business Finance
- Entrepreneurial Finance: Application of financial tools to fund, budget, and value new ventures. Focuses on how firms raise capital.
- Family Business Finance: The influence of family ownership on financial decisions. Research is mainly on capital structure in family firms.
Entrepreneurship
- Schumpeter's Definition: Five ways entrepreneurs create businesses: employing new technology, introducing new products/markets, and developing new resources.
- Howard Stevenson's Definition: The pursuit of opportunity beyond readily controlled resources.
Types of Entrepreneurial Ventures
- Salary Substitute Firms: Provide owners with income comparable to a conventional job.
- Lifestyle Firms: Allow owners to pursue a specific lifestyle while generating income.
- Entrepreneurial Firms: Create new services/products to respond to market needs without limitations on existing resources.
Family Business
- The definition of a family business is a complex challenge for researchers. There's no widely accepted definition.
- The Astrachan, Klein, and Smyrnios (2002) F-PEC scale is cited as way to evaluate the family-ness (assessing 'familyness') of an operation.
- F-PEC scale differentiates by 3 aspects: Power, Experience, and Culture. Power appears to be the most relevant one to analyze financing decisions.
Characteristics of Family Businesses in the Context of Financing Decisions
- Focus is on understanding how family considerations, ownership, and management interact in their financial decisions. (theories/hypotheses are presented).
Types of Family Businesses (Private vs. listed)
- Categorizes family businesses according to ownership and management structure.
Some Important and Well-Known Family Firms
- Shows examples of prominent family-owned businesses/firms.
MM (Modigliani & Miller) Model including (no) taxes and bankruptcy costs
- Dividend Irrelevance: The capital structure, in many theoretical cases, does not affect the value.
- MM Proposition I (No Tax/Bankruptcy): The value of a company is independent of capital structure.
- MM Proposition II (no tax/bankruptcy):* The cost of equity increases linearly with the gearing ratio.
- MM model expanded to incorporate the tax-deductibility of debt.
- Trade-off Theory: Explains that leverage-effects can both create value and lead to costs from bankruptcy risk.
Asymmetric Information and Capital Structure
- Information asymmetry leads to various observed phenomena, such as capital structure, signaling decisions and dividend policy.
- Pecking order theory highlights the importance of signaling in this environment.
Signaling by Raising Equity
- Managers may issue equity to signal positive information about their firm's prospects to the market
- Investors may interpret the issuance of equity differently depending on who is issuing it.
Signaling with Dividends
- A firm’s dividend policy may be used as a signal to convey information about the firm's prospects to the market.
- Signals of good prospects lead to higher stock prices, and vice versa.
Pecking Order Theory
- Firms prioritize retained earnings as a funding source to avoid the signaling problems associated with equity issues.
- Firms use debt before issuing new equity.
- Preferences are: retained earnings > debt financing > equity offerings.
Capital Structure Decision
- Summarizes the main ideas, theories, and where to see practical applications.
- Discussion of trade-offs between tax advantages and bankruptcy costs.
Payout Policy and Company Value: Theories
- Dividend Irrelevance: Payout policy is irrelevant to the firm’s value.
- Bird in the Hand: Investors prefer a safe dollar today, so cash dividends result in a higher perceived value.
- Tax Effects: Tax rates can influence investor preference for payout policy (dividends or retained earnings).
- Signaling Theory: Dividend payments, and other actions, signal firm prospects to the market.
Dividend Payments: Mechanics
- Dates: Key dates in a dividend payment schedule (Declaration, Ex-dividend, Record, Payment)
- Ex-Dividend Date: The day that a stock begins to trade without the included dividend.
- Price Effects: The price should typically decrease when a stock goes ex-dividend.
Share Repurchases
- A firm buys back its own shares.
- Share Repurchase implications: Partial liquidation, use as treasury stock (for employee compensation, acquisitions, or increased flexibility).
Dividend Irrelevance (Examples)
- Shows how the fundamental dividend irrelevance concept can be conceptually understood.
Relevance and Limitations of Theories for Family Firms
- The relevance and limitations of the various theories presented are considered.
Exercises (Examples)
- Equity Return and Leverage: Students are presented with a company that revises its capital structure and they must consider its consequences on the stock.
- Leverage and Cost of Capital: The capital structure is modified in this example, based on what the implications are on investment and financing decisions.
- Tax Shields and WACC: Examines how tax shields are dealt with in the context of firm valuation and capital structure.
- Trade-off Theory: Examines various scenarios relating to the choice of debt-versus-equity and its effect on firm value.
- Questions on Pecking Order Theory: Tests students' understanding of which firms use higher debt versus those with little.
- Dividend Policy: Questions on investors’ expectations and the effects of anticipated dividend payments on share prices.
- Share Repurchase and EPS Illusion: Analyzing share price adjustments due to share buybacks that use debt financing.
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Description
This quiz covers the fundamentals of corporate and entrepreneurial finance as part of the MSc Banking & Finance program. It explores key concepts such as capital structure theory and dividend policy, and includes practical exercises. Test your knowledge on these essential topics in corporate finance today!
