Question

1. how capital structure affects the value of a firm?

2. what are the Modigliani and Miller’s capital structure theories?

3 What have been the trends for dividend payments and stock buybacks (repurchases) over the past 25 years?

4 How do employee stock programs dilute the ownership of other stockholders? How do stock repurchases neutralize this effect?

5 What is rule 10b-18, what is its major provisions, and what is the goal of the rule?

6 Why is it important to focus on “operating” earnings, assets, and liabilities when calculating the value of a firm (especially for mergers and acquisitions)?

7 How are synergies from mergers and acquisitions incorporated into the free cash flows to the firm?

8 How does the choice of capital structure (and the resulting WACC) affect the value of the firm?

9 How are mergers and acquisitions paid for?

Answer 1

Answer(1): Capital structure decision involves the mix of equity and debt in the company, company needs funds to finance its operations and capital expenditures, for that purpose, company raises funds from the market by issuing share capital or bonds or takes loan from banks. Ratio of debt and equity in the firm's capital structure affects the value of firm. If a company's capital structure has more debt, it brings obligation and interest burden, if equity is more then company has to pay dividend to its shareholders. Capital structure decision affects the weighted average cost of capital (WACC).

Answer(2): Modigliani and Miller’s capital structure theories- This theory says that value of a firm is irrelevant to the capital structure. Market value of a company does not depend upon capital structure decision or is not affected by debt or leverage of the company rather it is affected by the operating profits of the company. Company's operating earnings play an important role in market value of the company.

Assumptions: Are as following:

• There are no taxes.
• No transaction cost.
• Cost of borrowing is same for investors and companies.
• No dividend and no floating cost.

Answer(3): In the past few years, dividend payment and stock repurchase have been adopted by the companies. Companies are now adopting modern approach that is "Shareholder's wealth maximization". Under this approach, shareholders' total value is increased by paying them handsome dividend regularly, company pays a part of its profits in the form of dividend. Company also repurchases shares from the stock market if share price is down and not giving profit to the shareholders, To increase the per share value, companies buys back the shares from the market.

Answer(7): Free cash flow is the cash that is available after paying capital expenditure. M&A brings synergy with it. Synergy is the same energy, Synergy can be defined as 1+1 do not equal to 2 rather 1+1 equal to 11. When two companies come together, they reap benefits by utilizing each other's resources. Cash flow is generated from the synergy. Cost comes down as both companies achieve economies of scale.

Answer(9): Mergers and Acquisition are the corporate actions, two companies can merge together or one big company takes over smaller company for expanding the business and utilizing the resources of another company. Mergers and Acquisitions can be paid fully in cash or partial cash and partial shares. Seller company will try to make higher value of the company while buyer will try to get the lowest price.

M&A can be paid with:

• Cash
• Stocks
• Debt