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461 Final Exam Study Guide

461 Final Exam Study Guide - Final Exam Study Guide Exam 1...

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Final Exam Study Guide Exam 1 Exam 2 Accretion/Dilution Analysis Premise Assesses the impact of an acquisition on the buyer’s EPS o Accretive combined EPS > Buyer’s EPS o Dilutive combined EPS < Buyer’s EPS o Breakeven combined EPS = Buyer’s EPS Wall Street doesn’t like Dilution because the relative EPS is decreasing. If you want to maintain the same PE ratio going forward while the EPS is decreasing, the share price is also going to decrease. Fundamental Flaw – we want the focus to be on earnings and this isn’t a cash flow base measure. Earnings are also easy to manipulate (could be flawed). Steps: 1. Estimate pro forma net income for combined entities a. Adjust: new buyer debt, excess cash/liquid securities for financing, synergies, options created into shares, deal-related fees, underwriting fees, and goodwill/incremental depreciation + amortization/ asset write up or downs 2. Calculate combined company’s new share count a. Based on existing buyer’s shares plus new shares created 3. Divide pro forma net income by pro forma share outstanding to arrive at pro forma EPS a. Pro Forma Net Income ÷ Pro Forma Shares Outstanding = PF EPS 4. Compare pro forma EPS to the buyer’s EPS without the transaction Leading Factors of Dilution Target has negative net income Target’s P/E > Buyer’s P/E (stock based transaction) Transaction results in significant amount of intangible assets to amortize Increased interest expense Decreased interest income Low/negative synergies Calculating Fully Diluted Shares Outstanding Treasury Stock Method o In-the-money options and warrants are exercised at weighted average strike price o Proceeds are used to repurchase shares at current market price o New shares are issued to fill the gap If –Converted Method o Convertible bond into stock (assume entire convertible is exchanged) Net share settlement method o Cash is used to settle the face value o Above the face value, new shares are issued Examples attached Hedge Funds Characteristics 1. Flexibility in relation to investments (long and short positions) – they can invest in anything
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a. Don’t depend on performance of broad markets and economy b. Lack of correlation is attractive to investors (attempt to lower risk without lowering returns, or vice versa) 2.
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