User:Haitham Ahmed Zaki/sandbox

What are the main steps in a capital budgeting process ? The typical steps in the capital budgeting process are: 1-Gathering investment ideas 2-Analyzing individual proposals, through doing forecasts on future cash flows and profitability 3-Planning the capital budget,through choosing the set of projects which make a better match with the company's strategies and scheduling and prioritizing these investment projects 4- Monitoring and post auditing, which would help improve business operations by working on deviations from the plan, and also help to develop more profitable investments through investing in already successful projects cut investments or cancel projects below expectations

What are the main classifications of capital budgeting projects? 1-replacement projects,like to replace a broken

2-Expansion projects, which are more risky than replacement projects

3-New products and services,which implies a higher level of uncertainty and requires the involvement of more people in the decision making process

4-Safety, regulatory and environmental projects which require only an analysis of whether to continue operations with the lower return or ROI expected after applying the new process, or to cease operating altogether or to shut down any part of the business that is related to the project. 5-other, which most probably require more complicated analysis techniques, other than NPV

What are the basic principles of capital budgeting ? 1- Capital budgeting isn't based on accounting concepts ( EX:it doesn't count for depreciation, amortization), and it's different from economic income (cash flow + change in the company's market value) 2-Timing of cash flow is crucial 3-Cash flows are analyzed on after tax basis 4-Financing costs are ignored, as they should be included already in the discount rate and deducting them again would make double-counting 5-Cash flows are based on opportunity costs

What's a sunk cost, opportunity cost, incremental cash flow,externality, conventional and non-conventional cash flow ?

A sunk cost is the cost that has been incurred in the past and can't be retrieved, and so shouldn't be taken in consideration at the time of decision making

An opportunity cost isÂ what a resource is worth in its next-best use

incremental cash flow is the cash flow that is realized because of a decision: the cash flow with a decision minus the cash flow without that decision

Externality is the effect of an investment on other things (like other department inside the company, effect on competitors, or even a positive effect on the society for whihc the company isn't compensated ) besides the investment itself

Conventional cash flows versus non-conventional cash flows.A conventional cash flow pattern is one with an initial outflow followed by a series of inflows (Like : -,+,+,+....etc). With a non conventional cash-flow the initial outflow is not followed by inflows only, but the cash flows can flip from positive to negative again

Note:An investment that involved outlays (negative cash flows) for the first couple of years that were then followed by positive cash flows would be considered to have a conventional pattern. If cash flows change signs once, the pattern is conventional. If cash flows change signs two or more times, the pattern is non conventional

What are the main challenges for incremental cash flow analysis ? 1-Independent projects versus mutually exclusive projects. Independent projects are projects whose cash flows are independent of each other. Mutually exclusive projects compete directly with each other

2-project sequencing, as the execution of one project in the upcoming period might depend on the success of another project in the current period

3- Unlimited funds versus capital rationing, An unlimited funds environment assumes that the company can raise the funds it wants for all profitable projects. simply by paying the required rate of return. Capital rationing exists when the company has a fixed amount of funds to invest, then it must allocate the funds to achieve the maximum shareholder value subject to the funding constraints

What's NPV and IRR ? NPV is the net present value of all cash flows (Inflows-outflows). IRR is the internal rate of return which makes the NPV equal zero.

What is the payback period, discounted payback period? and what's the disadvantage of each?

1- The payback period is the length of time required to recover the cost of an investment

The discount payback period is the length of time required for the cumulative discounted cash flow to equal the original investment

2- The disadvantages of both methods is that neither of them count for cash flows occurring after the payback period

The payback period has another disadvantage of not discounting the cash flows.

What's is the AAR, and what's its advantage ? AAR is the Average Accounting Return = (Average net income / average book value )

The main disadvantage is that it doesn't discount the income gained, and it's based on accounting income not actual cash flow

What's the profitability index, and how is it calculated ? The profitability index is the PV divided by the initial investment,so:

PI= (PV / Initial investment) = 1 + (NPV / Initial investments)

The investment decision rule for the PI is:

Invest if                    PI > 1.0

Do not invest if       PI < 1.0

Note:The PI is usually called the profitability index in corporations, but it is commonly referred to as a ―benefit–cost ratio‖ in governmental and not-for-profit organizations.

What's the NPV profile ? The NPV profile shows a project‘s NPV graphed as a function of various discount rates. Typically, the NPV is graphed vertically (on the y-axis), and the discount rates are graphed horizontally (on the x-axis). In case of IRR and NPV conflict. which metric should be used ? The NPV should be used instead of the the IRR, as the project with a higher IRR could be a smaller project. The NPV is also more realistic as it supposes reinvesting the inflows at the NPV rate, rather than reinvesting the inflows at the IRR rate which is unrealistically high. When does the multiple IRR problem or the no IRR problem happens? They might happen only with a non conventional cash flow and may never happen with a conventional cash flow. Having a non conventional cash flow doesn't incessantly mean that such a problem would happen. The number of sign change in the cash flow series is the maximum number of possible IRR (EX:if the cash flow sign change three times, like: - + - + + + ......etc, then the cash flow could have three, two, one, or even zero IRR

Note:the IRR and the NPV is more popular in large public corporations, while the payback period and the discounted payback period is more popular with small corporations

How are the shares prices of a specific company, affected by taking new projects ?

the change in the share's price is usually = The NPV of the new project / # of shares

The value of any company's shares is the PV of its current projects and any projects it would take in the future. The company's share price should change only if the PI of that new project is different from the average PI for all the company's projects. If the new project's PI is higher than average, the share's price would increase. If its' lower the share's price would decrease.

Usually, announcing of starting a new projects with positive PI is explained by the market as the firs of many other projects with positive PI, what would make the share's price increase go over the effect of the single NPV of the project announced.

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Reading 36

What's cost of capital, and what's a component cost of capital ?

Cost of a capital is the rate of return the supplier of capital - bondholders and shareholders - require as a compensation of their capital contribution.

A component cost of capital are bonds, equities, and any other reinstatement sharing the characteristics of debt and equity.

What's the weighted average cost of capital (WACC), and how is it calculated ?

the weighted average cost of capital is also known marginal cost of capital. It's calculated through the addition of the weighted cost of capital of each of the component cost of capital, like the below example:

WACC = WD*RD*(1-T)+WE*RE+WP*RP

Note: the weighted average cost of debt is multiplied by (1-T), because the tax legislation in the US implying deduction the interest of debt from the deductible amount. If the company takes a loan of 10 M $ with an interest rate of 10% annually with an average tax rate of 20 %, then the actual cost of debt would be 1M$- (1M$ *20%)= 0.8 M$. The previous statement also means that the actual interest rate on interest is 0.8 / 10 = 8%

What are the main approaches of measuring the weighted average ?

1- Assuming the company‘s current capital structure, as the target capital structure. 2- Examine trends in the company‘s capital structure or statements by management regarding capital structure policy to infer the target capital structure. 3-Use averages of comparable companies‘ capital structures as the target capital structure.

Note: to convert a debt to equity ratio to a debt to capital ratio, follow the below equation: D / C = (D/E) / (1+(D/E))

How to determine the required rate of return for any given project within a company ?

It should be the marginal cost of capital, which is the extra cost of capital the company has to pay to collect the capital necessary for the project.

What should be the highest acceptable cost of capital for any given company ?

The highest acceptable cost of capital should be equal to the highest possible return on investment. Theoretically, the company should take all the projects with marginal cost of capital lower than its respective return on capital.

What are the underlying assumptions of using the company WACC as NPV discount rate for one of the company's projects ?

1- That assumes that the project has the same level of risk as the average risk of the overall projects of that company 2-That assumes that the project's capital structure would stay constant during its useful life.

Page 60

EXAMPLE 4 ..........Financial Calculator Example 8...........solve Check all the equations

The cost of debt is the cost of debt financing to a company when it issues a bond or takes out a bank loan

The yield to maturity (YTM) is the annual return that an investor earns on a bond if the investor purchases the bond today and holds it until maturity.

the debt-rating approach can be used to estimate the before-tax cost of debt. Based on a company‘s debt rating, we estimate the before-tax cost of debt by using the yield on comparably rated bonds for maturities that closely match that of the company‘s existing debt.

Suppose a company‘s capital structure includes debt with an average maturity (or duration) of 10 years and the company‘s marginal tax rate is 35 percent. If the company‘s rating is AAA and the yield on debt with the same debt rating and similar maturity (or duration) is 4 percent, the company‘s after-tax cost of debt is9 rd(1 – t) = 4 percent(1 – 0.35) = 2.6 percent

Other factors, such as debt seniority and security, also affect ratings

so care must be taken to consider the likely type of debt to be issued by the company

evaluated pricing or matrix pricing.

prime rate or Libor,

a callable bond would have a yield greater than a similar noncallable bond of the same issuer because bondholders want to be compensated for the call risk associated with the bond.

the put feature of a bond, which provides the investor with an option to sell the bond back to the issuer at a predetermined price, has the effect of lowering the yield on a bond below that of a similar nonputable bond.

If the company already has debt outstanding incorporating optionlike features that the analyst believes are representative of the future debt issuance of the company, the analyst may simply use the yield to maturity on such debt in estimating the cost of debt.

If the analyst believes that the company will add or remove option features in future debt issuance, the analyst can make market value adjustments to the current YTM to reflect the value of such additions and/or deletions.

Though researchers offer approaches for estimating a company‘s ―synthetic‖ debt rating based on financial ratios, these methods are imprecise because debt ratings incorporate not only financial ratios but also information about the particular bond issue and the issuer that are not captured in financial ratios.

3.1.3.4. Leases

The cost of preferred stock is the cost that a company has committed to pay preferred stockholders as a preferred dividend when it issues preferred stock. In the case of nonconvertible, noncallable preferred stock that has a fixed dividend rate and no maturity date (fixed rate perpetual preferred stock), we can use the formula for the value of a preferred stock: where

there is no adjustment made based upon the marginal tax rate.

the selection of the appropriate risk-free rate should be guided by the duration of projected cash flows. If we are evaluating a project with an estimated useful life of 10 years, we may want to use the rate on the 10-year Treasury bond.

Cost of common stock = 5 percent + 1.5(7 percent) = 15.5 percent.

dividend discount model based approach or implied risk premium approach, which is implemented using the Gordon growth model (also known as the constant-growth dividend discount model).

survey approach.....Ask a panel of finance experts for their estimates and take the mean response.

The bond yield plus risk premium approaches based on the fundamental tenet in financial theory that the cost of capital of riskier cash flows is higher than that of less risky cash flows.

we often estimate this premium using historical spreads between bond yields and stock yields.

______________________________________________________ Reading 37

What's leverage ? and what's the importance of measuring a company's leverage?

1-

Leverage is the use of fixed costs in a company‘s cost structure.

2-   A-Assess the company's risk and return characteristics B- Forecast a company‘s business and future prospects from management‘s decisions about the use of operating and financial leverage C-A company‘s use of leverage should help in forecasting cash flows and in selecting an appropriate discount rate for finding their present value

What's business risk, sales risk, operating risk, and financial risk ?

Business risk is the risk associated with operating earnings, and consists of sales risk and operating risk.

Sales risk is the uncertainty with respect to the price and quantity of goods and services

Operating risk is the risk attributed to the operating cost structure, in particular the use of fixed costs in operations. The greater the fixed operating costs relative to variable operating costs, the greater the operating risk.

What's cost structure? and what's the difference between variable costs and fixed costs ?

1-

Cost structure of a company is the mix of variable and fixed costs

2- Variable costs fluctuate with the level of production and sales.

Fixed costs are expenses that are the same regardless of the production and sales of the company.

What's the degree of operating leverage {DOL} ? and how to calculate it?

1- The degree of operating leverage {DOL} is the operating income elasticity.

2- DOL = {Percentage change in operation income / Percentage change in units sold}

What's the per unit contribution margin, the contribution margin ? and how to calculate each?

1- per unit contribution margin is the amount that each unit sold contributes to covering fixed costs—that is, the difference between the price per unit and the variable cost per unit.

contribution margin is the per unit contribution margin multiplied by the number of units sold, or revenue minus variable costs.

2- DOL=Q(P−V)/ {Q(P−V)−F}

Note: Industries that tend to have high operating leverage are those that invest up front to produce a product but spend relatively little on making and distributing it. Software developers and pharmaceutical companies fit this description. Alternatively, retailers have low operating leverage because much of the cost of goods sold is variable.

Note:

Because most companies produce more than one product, the ratio of variable to fixed costs is difficult to obtain. We can get an idea of the operating leverage of a company by looking at changes in operating income in relation to changes in sales for the entire company.

What's financial risk? and what's the degree of financial leverage, and how to calculate it

1- Financial risk is the risk associated with how a company finances its operations.

2- Degree of financial leverage (DFL) is a metric that measures the sensitivity of a company's operating income due to changes in its capital structure.

3- DFL=% change in net income / % change in operating income

What's total leverage? and how to calculate it? 1-

It's a measure of the sensitivity of net income to changes in the number of units produced and sold.

2- DTL=PercentagechangeinnetincomePercentagechangeinthenumberofunitssold

What's the operating breakeven point? and how to calculate it?

1- It's the production level where revenue equal the operating costs

2-

What's the difference between reorganization and liquidation ?

Reorganization provided by American courts give companies with a viable business temporary protection for companies against it creditors. Creditors can't claim the company during this time for the principle or interest.

Liquidation allows for the orderly satisfaction of the creditors‘ claims, through liquidating the company's assets and and pay its debtors back.

____________________________________________________________

Reading 38

What's cost of capital, and what's a component cost of capital ?

Cost of a capital is the rate of return the supplier of capital - bondholders and shareholders - require as a compensation of their capital contribution.

A component cost of capital are bonds, equities, and any other reinstatement sharing the characteristics of debt and equity.

What's the weighted average cost of capital (WACC), and how is it calculated ?

the weighted average cost of capital is also known marginal cost of capital. It's calculated through the addition of the weighted cost of capital of each of the component cost of capital, like the below example:

WACC = WD*RD*(1-T)+WE*RE+WP*RP

Note: the weighted average cost of debt is multiplied by (1-T), because the tax legislation in the US implying deduction the interest of debt from the deductible amount. If the company takes a loan of 10 M $ with an interest rate of 10% annually with an average tax rate of 20 %, then the actual cost of debt would be 1M$- (1M$ *20%)= 0.8 M$. The previous statement also means that the actual interest rate on interest is 0.8 / 10 = 8%

What are the main approaches of measuring the weighted average ?

1- Assuming the company‘s current capital structure, as the target capital structure. 2- Examine trends in the company‘s capital structure or statements by management regarding capital structure policy to infer the target capital structure. 3-Use averages of comparable companies‘ capital structures as the target capital structure.

Note: to convert a debt to equity ratio to a debt to capital ratio, follow the below equation: D / C = (D/E) / (1+(D/E))

How to determine the required rate of return for any given project within a company ?

It should be the marginal cost of capital, which is the extra cost of capital the company has to pay to collect the capital necessary for the project.

What should be the highest acceptable cost of capital for any given company ?

The highest acceptable cost of capital should be equal to the highest possible return on investment. Theoretically, the company should take all the projects with marginal cost of capital lower than its respective return on capital.

What are the underlying assumptions of using the company WACC as NPV discount rate for one of the company's projects ?

1- That assumes that the project has the same level of risk as the average risk of the overall projects of that company 2-That assumes that the project's capital structure would stay constant during its useful life.

Page 60

EXAMPLE 4 ..........Financial Calculator Example 8...........solve Check all the equations

The cost of debt is the cost of debt financing to a company when it issues a bond or takes out a bank loan

The yield to maturity (YTM) is the annual return that an investor earns on a bond if the investor purchases the bond today and holds it until maturity.

the debt-rating approach can be used to estimate the before-tax cost of debt. Based on a company‘s debt rating, we estimate the before-tax cost of debt by using the yield on comparably rated bonds for maturities that closely match that of the company‘s existing debt.

Suppose a company‘s capital structure includes debt with an average maturity (or duration) of 10 years and the company‘s marginal tax rate is 35 percent. If the company‘s rating is AAA and the yield on debt with the same debt rating and similar maturity (or duration) is 4 percent, the company‘s after-tax cost of debt is9 rd(1 – t) = 4 percent(1 – 0.35) = 2.6 percent

Other factors, such as debt seniority and security, also affect ratings

so care must be taken to consider the likely type of debt to be issued by the company

evaluated pricing or matrix pricing.

prime rate or Libor,

a callable bond would have a yield greater than a similar noncallable bond of the same issuer because bondholders want to be compensated for the call risk associated with the bond.

the put feature of a bond, which provides the investor with an option to sell the bond back to the issuer at a predetermined price, has the effect of lowering the yield on a bond below that of a similar nonputable bond.

If the company already has debt outstanding incorporating optionlike features that the analyst believes are representative of the future debt issuance of the company, the analyst may simply use the yield to maturity on such debt in estimating the cost of debt.

If the analyst believes that the company will add or remove option features in future debt issuance, the analyst can make market value adjustments to the current YTM to reflect the value of such additions and/or deletions.

Though researchers offer approaches for estimating a company‘s ―synthetic‖ debt rating based on financial ratios, these methods are imprecise because debt ratings incorporate not only financial ratios but also information about the particular bond issue and the issuer that are not captured in financial ratios.

3.1.3.4. Leases

The cost of preferred stock is the cost that a company has committed to pay preferred stockholders as a preferred dividend when it issues preferred stock. In the case of nonconvertible, noncallable preferred stock that has a fixed dividend rate and no maturity date (fixed rate perpetual preferred stock), we can use the formula for the value of a preferred stock: where

there is no adjustment made based upon the marginal tax rate.

the selection of the appropriate risk-free rate should be guided by the duration of projected cash flows. If we are evaluating a project with an estimated useful life of 10 years, we may want to use the rate on the 10-year Treasury bond.

Cost of common stock = 5 percent + 1.5(7 percent) = 15.5 percent.

dividend discount model based approach or implied risk premium approach, which is implemented using the Gordon growth model (also known as the constant-growth dividend discount model).

survey approach.....Ask a panel of finance experts for their estimates and take the mean response.

The bond yield plus risk premium approaches based on the fundamental tenet in financial theory that the cost of capital of riskier cash flows is higher than that of less risky cash flows.

we often estimate this premium using historical spreads between bond yields and stock yields.

______________________________________________________ Reading 37

What's leverage ? and what's the importance of measuring a company's leverage?

1-

Leverage is the use of fixed costs in a company‘s cost structure.

2-   A-Assess the company's risk and return characteristics B- Forecast a company‘s business and future prospects from management‘s decisions about the use of operating and financial leverage C-A company‘s use of leverage should help in forecasting cash flows and in selecting an appropriate discount rate for finding their present value

What's business risk, sales risk, operating risk, and financial risk ?

Business risk is the risk associated with operating earnings, and consists of sales risk and operating risk.

Sales risk is the uncertainty with respect to the price and quantity of goods and services

Operating risk is the risk attributed to the operating cost structure, in particular the use of fixed costs in operations. The greater the fixed operating costs relative to variable operating costs, the greater the operating risk.

What's cost structure? and what's the difference between variable costs and fixed costs ?

1-

Cost structure of a company is the mix of variable and fixed costs

2- Variable costs fluctuate with the level of production and sales.

Fixed costs are expenses that are the same regardless of the production and sales of the company.

What's the degree of operating leverage {DOL} ? and how to calculate it?

1- The degree of operating leverage {DOL} is the operating income elasticity.

2- DOL = {Percentage change in operation income / Percentage change in units sold}

What's the per unit contribution margin, the contribution margin ? and how to calculate each?

1- per unit contribution margin is the amount that each unit sold contributes to covering fixed costs—that is, the difference between the price per unit and the variable cost per unit.

contribution margin is the per unit contribution margin multiplied by the number of units sold, or revenue minus variable costs.

2- DOL=Q(P−V)/ {Q(P−V)−F}

Note: Industries that tend to have high operating leverage are those that invest up front to produce a product but spend relatively little on making and distributing it. Software developers and pharmaceutical companies fit this description. Alternatively, retailers have low operating leverage because much of the cost of goods sold is variable.

Note:

Because most companies produce more than one product, the ratio of variable to fixed costs is difficult to obtain. We can get an idea of the operating leverage of a company by looking at changes in operating income in relation to changes in sales for the entire company.

What's financial risk? and what's the degree of financial leverage, and how to calculate it

1- Financial risk is the risk associated with how a company finances its operations.

2- Degree of financial leverage (DFL) is a metric that measures the sensitivity of a company's operating income due to changes in its capital structure.

3- DFL=% change in net income / % change in operating income

What's total leverage? and how to calculate it? 1-

It's a measure of the sensitivity of net income to changes in the number of units produced and sold.

2- DTL=PercentagechangeinnetincomePercentagechangeinthenumberofunitssold

What's the operating breakeven point? and how to calculate it?

1- It's the production level where revenue equal the operating costs

2-

What's the difference between reorganization and liquidation ?

Reorganization provided by American courts give companies with a viable business temporary protection for companies against it creditors. Creditors can't claim the company during this time for the principle or interest.

Liquidation allows for the orderly satisfaction of the creditors‘ claims, through liquidating the company's assets and and pay its debtors back.

____________________________________________________________

Reading 38

What is a dividend? A dividend is a distribution paid to shareholders based on the number of shares owned.

What's a payout, and what's a payout policy?

A payout is cash dividends and the value of shares repurchased in any given year

A payout policy is the set of principles guiding payouts.

What are the main categories of dividends?

A-Regular Cash Dividends some companies pay dividends to its shareholders annually,semi-annually, or quarterly

B-Extra or Special (Irregular) Dividends

It's a dividend paid by a company that does not pay dividends on a regular schedule, or a dividend that supplements regular cash dividends with an extra payment.

C-Liquidating Dividends

A dividend may be referred to as a liquidating dividend when a company:

 goes out of business and the net assets of the company (after all liabilities have been paid) are distributed to shareholders;  sells a portion of its business for cash and the proceeds are distributed to shareholders; or  pays a dividend that exceeds its accumulated retained earnings (impairs stated capital).

D-Stock Dividends

Stock dividends are a non-cash form of dividends. With a stock dividend (also known as a bonus issue of shares), the company distributes additional shares (typically 2–10 percent of the shares then outstanding) of its common stock to shareholders instead of cash.

Note: Although the shareholder‘s total cost basis remains the same, the cost per share held is reduced. For example, if a shareholder owns 100 shares with a purchase price of $10 per share, the total cost basis would be $1,000. After a 5 percent stock dividend, the shareholder would own 105 shares of stock at a total cost of $1,000. However, the cost per share would decline to $9.52 ($1,000/105).

E-Stock Splits

Stock splitting is offering (say) two stocks for each stock held. Although two-for-one and three-for-one stock splits are the most common, unusual splits, such as five-for-four or seven-for-three, sometimes occur.

Note: From a company‘s perspective, the key difference between a stock dividend and a cash dividend is that a cash dividend affects a company‘s capital structure, whereas a stock dividend has no economic impact on a company. Cash dividends reduce assets (because cash is being paid out) and shareholders‘ equity (by reducing retained earnings).

What's the difference between cash dividends and stock dividends?

From a company‘s perspective, the key difference between a stock dividend and a cash dividend is that a cash dividend affects a company‘s capital structure, whereas a stock dividend has no economic impact on a company. Cash dividends reduce assets (because cash is being paid out) and shareholders‘ equity (by reducing retained earnings).

Both stock dividends and stock splits have no effect on total shareholders‘ equity, a stock dividend is accounted for as a transfer of retained earnings to contributed capital. A stock split, however, does not affect any of the balances in shareholder equity accounts.

What are the positive effects of stock split?

With more shares outstanding, there is a higher probability that more individual shareholders will own the stock—almost always a plus for companies.

What's reverse stock split?

A reverse stock split increases the share price and reduces the number of shares outstanding—again, with no effect on the market value of a company‘s equity or on shareholders‘ total cost basis.

The objective of a reverse stock split is to increase the price of the stock to a higher, more marketable range, to reach the minimum listing requirements, or to become up to the standards of institutional investors and mutual funds that often shy from buying stocks trading below $5.

What's dividends reinvestment plan (DPRs) ?what are it main types? and what are its advantages and disadvantages ?

1- It's a system that allows shareholders to automatically reinvest all or a portion of cash dividends from a company in additional shares of the company.

Such a dividend reinvestment plan is referred to as a DRP (pronounced ―drip‖ and therefore often represented also as (DRIP‖)

2-

It has two main types :

A- open-market DRPs in which the company purchases shares in the open market to acquire the additional shares credited to plan participants

B- new-issue DRPs (also referred to as scrip dividend schemes in the United Kingdom5) in which the company meets the need for additional shares by issuing them instead of purchasing them.

3- The advantages are: A- Providing small shareholders an easy means to accumulate additional shares. B- New-issue DRPs allow the company to raise new equity capital without the flotation costs. C- Typically new-issue DRPs, offer the additional benefit to DRP participants of purchasing shares at a discount (usually 2–5 percent)

Note: New issue DRPs dilute the holdings of shareholders who do not participate in the DRP.

The only disadvantage is that : cash dividends are fully taxed in the year received even when reinvested, which means the shareholder is paying tax on cash not actually received.

What's the payment chronology of dividends ?

A- Declaration date It's the date on which the company declares dividends payment date, ex- dividend date, and holder of record date. B- Ex-dividend date The ex-date is the first date that a share trades without the dividend. The holder of the share before that date, is the one who receives the dividend. On the Ex-date the dividend should be traded at the closing rate of the previous trading session minus the amount of the dividend. C- Holder of record date; also known as record date and closure date Trades usually take 3 days to be settled. For Example, if the ex-date is on the 15 of October the holder of record date should be on the 17 of October, to give enough time for investors who bought the share on the 14 to have their trade reflected on the system and to be recognized as the shareholders who would receive the dividends. To give trades enough time to be settled, a holder of record date is assigned a couple of days after the ex-dividend date, to declare the shareholders who would receive the upcoming dividend.

Note: the difference between the holder of record date and the ex- dividend date depends on the settlement period in the related stock market

D- Payment date It is the day that the company transfers the dividend. Unlike other pertinent dates, such as the ex-date and record date which occur only on business days, the payment date can occur on a weekend or holiday.

What are share repurchases? and what characterizes the repurchased stocks from any other stock ?

1- A share repurchase (or buyback) is a transaction in which a company buys back its own shares. Unlike stock dividends and stock splits, share repurchases use corporate cash. 2- Shares that have been issued and subsequently repurchased are classified as treasury shares (treasury stock) or in some jurisdictions canceled; in either case they are not then considered for dividends, voting, or computing earnings per share.

What's the difference between share repurchasing and dividends?

A- Unlike stock dividends and stock splits, share repurchases use corporate cash. Hence, share repurchases can be viewed as an alternative to cash dividends.

B- In general, when an amount of share repurchases is authorized, the company is not strictly committed to carrying through with repurchasing shares.When dividends are declare,the company becomes committed to pay the dividends.

C- Another contrast with cash dividends is that whereas cash dividends are distributed to shareholders proportionally to their ownership percentage, share repurchases in general do not distribute cash in such a proportionate manner.

What are the advantages of shares repurchases from the company's perspective ?

A- To communicate that management perceives shares in the company to be undervalued in the marketplace or more generally to support share prices B- Flexibility in distributing cash to shareholders in terms of amount and timing C- To absorb increases in shares outstanding resulting from the exercise of employee stock options

What are the share repurchase methods ? A- Buy in the open market This is the most flexible repurchase method, by allowing the company to repurchase at whatever suitable time for its interests. B- Buy back a fixed number of shares at a fixed price This method is also called fixed price tender offer. If shareholders are willing to pay more than what the company offers, then each shareholder offer would be accepted on peroration basis. Usually the company offers a premium price. C- Dutch auction By this method, the company offers to buy (X) number of shares at price between (Y : Y +2). The company accepts the lowest offers firs D- Repurchase by direct negotiation Which depends mainly on taking advantage of the weak financial positions of the main shareholders in a company, through buying their share at relatively cheap price. How does share repurchasing affect the balance sheet and the income statement?

A- On the balance sheet the amount of cash and the book value of equity are both decreased by the amount of repurchase

B- On the income statement, would reflect on the EPS(earnings per share) by increasing or decreasing it. The effect depends on the cost of money used to make the repurchase relative to the the current EPS.

In the case of internal financing, a repurchase increases EPS only if the funds used for the repurchase would not earn their cost of capital if retained by the company.26 In the case of external financing, the effect on EPS is positive if the earnings yield exceeds the after-tax cost of financing the repurchase.

How does share repurchase affect the book value per share?

This example shows that when the market price per share is greater than its book value per share, BVPS will decrease after the share repurchase. When the market price per share is less than BVPS, however, BVPS will increase after a share repurchase.

Note: The share repurchase and cash dividends both have the same effect on the wealth of share holders { assuming no difference in tax rates for using each method}

How could share repurchase through direct negotiation affect the share's price?

If the share is purchased at a premium, the shareholders' wealth would be transferred to the shareholder the company bought from. In such a scenario, the shareholders' wealth would be decreased by the amount of the premium paid. If the share is purchased at rate lower than the market's rate, the shareholders' wealth would be increased by the difference between the market's price and the price of repurchase.

Note: Share repurchase usually make the share's price increases, as investors realize it as a as a movement from the company to adjust the value for its undervalued share. Also, share dividends is seen by investors as sign of management‘s confidence in forward-looking profitability. This fact make company shares increase strongly after the announcement of its firs dividend payment. ________________________________________________________________

Reading 39 What's liquidity?

Liquidity is the extent to which a company is able to meet its short-term obligations using assets that can be easily transformed into cash.

what are the primary and secondary sources of liquidity? And what's the difference between them?

1-   A- The primary sources of liquidity are: 1]Ready cash balance; whether in bank accounts or in the treasury 2]Short term funds; like trade credit, bank credit lines, and short term securities 3]Cash flows management,which is the company‘s effectiveness in its cash management system and practices B- The second sources of liquidity are: 1]Negotiating debt contracts, relieving pressures from high interest payments or principal repayments 2]liquidating assets 3]Filling for bankruptcy under reorganization 2- The main difference between primary and secondary sources of liquidity is that using a primary source is not likely to affect the normal operations of the company, and they are readily accessible at a relatively low cost. Secondary resources on the opposite may result in a change in the company‘s financial and operating positions.

What are liquidity pulls and drags and what cause each ?

Liquidity drags is when receipts lag cause pressure on available funds.

Causes of liquidity drags include: A-Uncollected receivables B- Obsolete inventory C- Tight credit : When economic conditions make capital scarcer, short-term debt becomes more expensive to arrange and use

Liquidity pulls is when disbursements are paid too quickly or trade credit availability is limited, requiring companies to expend funds before they receive funds from sales that could cover the liability.

Causes of liquidity pulls include: A- Making payments early. B- Reduced credit limits. C- Limits on short-term lines of credit. D- Low liquidity positions. Many companies face chronic liquidity shortages, often because of their particular industry or from their weaker financial position.