Corporate Finance Advisory Flashcards

Question 1

What is the main goal of corporate finance decision making?

Accepted Answer

The main goal is to maximize long-term shareholder value, meaning decisions should increase owner wealth after accounting for risk. Managers and advisors judge investments, financing choices and payouts by whether they create more value than they cost. Accounting profit alone is not enough, because it ignores timing, risk and the cash returned to investors.

Question 2

What does the time value of money principle state?

Accepted Answer

A dollar available today is worth more than the same dollar received in the future, because it can be invested and earn a return. Advisors use this idea to compare cash flows that arrive at different times. They discount future amounts at a rate reflecting risk and opportunity cost, enabling fair comparison.

Question 3

What is the difference between net present value and internal rate of return?

Accepted Answer

Net present value is discounted future cash flows minus the initial investment, measured in currency. Internal rate of return is the discount rate that makes that net present value equal zero, expressed as a percentage. When projects are mutually exclusive, net present value is generally the more reliable guide for choosing among them.

Question 4

Why do advisors focus on cash flows rather than accounting earnings?

Accepted Answer

Cash flows show the money a business actually generates and can distribute to lenders and owners. Accounting earnings include non-cash items such as depreciation, accruals and estimates that can be shifted by policy choices. Valuation and financing decisions depend on available cash, so cash-based measures are usually more dependable.

Question 5

What is the role of a financial advisor in a transaction?

Accepted Answer

A financial advisor helps a client make and execute a major decision, such as a sale, purchase, financing or restructuring. Work includes valuing the business, identifying counterparties, preparing materials, negotiating terms and coordinating lawyers, accountants and lenders. The advisor works for the client, so advice should serve the client's interests first.

Question 6

What is the difference between a sell-side and buy-side advisor?

Accepted Answer

A sell-side advisor represents the company or owners who want to sell a business, division or asset, aiming for the best price. A buy-side advisor represents the party acquiring a business, focusing on valuation discipline, financing and deal risk. Both roles require understanding the other side's likely position, but their incentives and deliverables differ.

Question 7

Why do companies hire outside advisors for major transactions?

Accepted Answer

Companies hire outside advisors for expertise, objectivity and access to buyers, lenders or investors they may not know well. Internal teams are often busy with daily operations and may lack recent market data. An outside advisor can also absorb tough negotiating positions, protecting management relationships.

Question 8

What is a fairness opinion in a corporate transaction?

Accepted Answer

A fairness opinion is a written view from an independent advisor stating whether a transaction's price is financially fair to the party receiving it. It usually summarizes the valuation analyses supporting that view. It does not tell shareholders how to vote, nor guarantee the best available price.

Question 9

What is the basic idea behind discounted cash flow valuation?

Accepted Answer

Discounted cash flow valuation estimates a business's value as the present value of the cash flows it is expected to generate. Analysts forecast free cash flow, estimate a terminal value, and discount both at a rate reflecting risk. Its reliability depends heavily on assumptions about growth and the discount rate.

Question 10

What is a discount rate, and how is it commonly estimated?

Accepted Answer

The discount rate is the return investors require for bearing a project's or company's risk, so it reflects opportunity cost. A common approach is the weighted average cost of capital, blending debt and equity costs. Cost of equity is often estimated with the capital asset pricing model.

Question 11

How does the terminal value affect a valuation?

Accepted Answer

Terminal value captures cash flows beyond the explicit forecast period and often makes up a large share of enterprise value. Small changes in the long-term growth rate or the discount rate can therefore move the result substantially. Advisors therefore test a range of assumptions and check the implied exit multiple against market evidence.

Question 12

How does comparable company analysis estimate a firm's value?

Accepted Answer

Comparable company analysis estimates value by applying market multiples, such as enterprise value to EBITDA or price to earnings, from similar publicly traded firms. The analyst selects peers by industry, size, growth and risk. These multiples are applied to the target's matching metric. Peer selection strongly shapes the result.

Question 13

How does precedent transaction analysis differ from trading comparables?

Accepted Answer

Precedent transaction analysis values a company using multiples paid in past acquisitions of similar businesses. It differs from trading comparables because the multiples include a control premium, the extra price a buyer pays to gain control. Analysts must still adjust for timing and deal specifics.

Question 14

Why do analysts often use a range of valuation methods?

Accepted Answer

Analysts use several methods because each has different assumptions, so no single figure captures value with certainty. Discounted cash flow reflects intrinsic cash generation, while market multiples reflect current investor sentiment. Comparing results shows where estimates converge and diverge, helping set a defensible negotiating range.

Question 15

What are common sensitivity analyses used in valuation?

Accepted Answer

Sensitivity analysis shows how a valuation changes when key inputs move, such as growth, margin or discount rate. Analysts often present a grid so readers can see which assumptions matter most. Scenario analysis extends this by modeling coherent sets of assumptions, such as base, upside and downside cases.

Question 16

What does enterprise value represent compared with equity value?

Accepted Answer

Enterprise value represents the total value of a company's operating assets attributable to all capital providers, including both debt and equity holders. Equity value is what remains for shareholders after subtracting net debt and other claims such as preferred stock and noncontrolling interests. Keep definitions consistent when comparing multiples.

Question 17

What does the term capital structure describe in corporate finance?

Accepted Answer

Capital structure describes the mix of debt and equity a company uses to finance its assets and operations. Debt includes bank loans and bonds that require fixed payments, while equity includes common and preferred shares that carry residual claims. The mix affects financial risk, cost of capital and flexibility during downturns.

Question 18

How does the tax deductibility of interest affect financing choices?

Accepted Answer

Interest payments are generally tax deductible, which lowers the after-tax cost of debt compared with the pre-tax rate. This creates a tax shield that can make debt attractive relative to equity, all else equal. However, higher debt raises distress costs, so the benefit must be weighed against them.

Question 19

What does the trade-off theory of capital structure propose?

Accepted Answer

The trade-off theory says firms balance debt's tax benefits against distress costs to reach an optimal leverage level. Companies with stable, tangible assets may borrow more, since those assets support lending and retain value in trouble. Firms with volatile earnings often borrow less, because a downturn could make required payments hard to meet.

Question 20

How does the pecking order theory explain corporate financing decisions?

Accepted Answer

The pecking order theory holds that managers prefer internal funds first, then debt, and issue new equity only as a last resort. This ordering arises because outside investors may undervalue new shares, creating information asymmetry about the firm's true prospects. Leverage therefore reflects cumulative external funding needs, not a fixed target.

Question 21

What are the main types of debt financing available to companies?

Accepted Answer

Common debt financing includes bank term loans, revolving credit facilities, senior notes, high-yield bonds and private placements. Term loans have scheduled repayments, while revolvers let a company borrow, repay and reborrow up to a set limit. Covenants in loan agreements often restrict dividends, asset sales or further borrowing.

Question 22

What is the difference between senior and subordinated debt?

Accepted Answer

Senior debt has a higher claim on assets and cash flows than subordinated debt, so it is repaid first. Subordinated debt ranks below senior creditors but above equity and usually pays more interest. Secured loans add collateral, which can rank them ahead of unsecured debt.

Question 23

How do loan covenants help lenders manage the risk of default?

Accepted Answer

Loan covenants are contractual promises that limit borrower actions and require certain financial conditions to be maintained. Affirmative covenants require reporting and insurance, while negative covenants restrict new debt, asset sales or large acquisitions without lender consent. Financial covenants, such as minimum interest coverage, give lenders early warning of weakening performance.

Question 24

How do dividend decisions interact with a company's financing needs?

Accepted Answer

Dividend decisions compete with investment for the same cash, so paying dividends can increase the need for external financing. A firm that pays out most of its earnings may have to borrow or issue shares to fund growth projects. Many managers therefore favor stable, predictable payouts and plan investment and debt around them.

Question 25

What are the main stages of a typical sell-side M&A process?

Accepted Answer

A typical sell-side process begins with preparation, including valuation, an information memorandum and identifying potential buyers. It then moves to marketing, where nondisclosure agreements are signed and indicative offers are collected. Next, shortlisted bidders receive due diligence access and submit binding offers, and the process ends with negotiation, signing and closing.

Question 26

What does due diligence involve during an acquisition?

Accepted Answer

Due diligence is the buyer's structured investigation of the target company's financial, legal, tax, operational, commercial and environmental position. Teams review audited accounts, contracts, customer concentration, litigation, employee arrangements and regulatory compliance. The findings shape the final price, the representations and warranties in the agreement, and the indemnities or escrow the buyer requests.

Question 27

What is synergy in a merger, and why is it often overestimated?

Accepted Answer

Synergy is the extra value created when combined companies outperform their separate parts. Synergies are often overestimated because planners underrate integration costs, customer loss and the time needed to realize benefits. Careful advisors separate cost synergies, which are more controllable, from less certain revenue synergies.

Question 28

How does a leveraged buyout use borrowed money to fund an acquisition?

Accepted Answer

A leveraged buyout is an acquisition funded mainly with debt, with the target's own cash flows and assets typically supporting repayment. A financial sponsor usually contributes a smaller equity stake, and lenders provide senior and sometimes subordinated debt. The aim is to improve operations, then sell or refinance at a higher value.

Question 29

How is consideration typically structured in an acquisition?

Accepted Answer

Consideration is the payment a buyer offers target shareholders, commonly structured as all cash, all stock or a combination of both. Cash offers give sellers certainty and quick value, but they require the buyer to finance the payment. Stock offers share risk and upside with sellers, but share values can move before closing.

Question 30

What is an earn-out, and when is it used?

Accepted Answer

An earn-out is a deal term where part of the purchase price depends on the target achieving specified financial or operational goals after closing. It is often used when buyer and seller disagree about future performance. Earn-outs require precise definitions of metrics and accounting policies, since disputes are common.

Question 31

What is the purpose of a break-up fee in a merger agreement?

Accepted Answer

A break-up fee is a payment owed if a merger agreement is terminated under specified circumstances. It compensates the other party for time, expenses and lost opportunity, and helps deter competing bids. Fee size is negotiated, typically as a percentage of the transaction value.

Question 32

What is the role of a regulatory review in a large acquisition?

Accepted Answer

Regulatory review examines whether a proposed acquisition could reduce competition, harm consumers or raise national security concerns. Depending on jurisdiction and deal size, authorities may require filings, waiting periods and information requests before closing can occur. Remedies such as divestitures are sometimes negotiated, and deals may be delayed or blocked.

Question 33

What does a restructuring advisor typically do for a distressed company?

Accepted Answer

A restructuring advisor helps a stressed company assess options, stabilize liquidity and negotiate with creditors. Typical tasks include a thirteen-week cash flow forecast, capital structure review and asset sale analysis. The goal is to preserve value and reach a workable outcome, out of court or through a formal process.

Question 34

What is a thirteen-week cash flow forecast used for?

Accepted Answer

A thirteen-week cash flow forecast projects weekly receipts and payments over one quarter, showing whether the company can meet obligations. It is widely used in distressed situations because liquidity problems can become urgent quickly. Management updates it weekly, comparing actual results with forecasts to find funding gaps early.

Question 35

How does an out-of-court restructuring differ from a formal bankruptcy?

Accepted Answer

An out-of-court restructuring is negotiated privately with creditors, avoiding court supervision but requiring broad agreement. A formal bankruptcy runs under court supervision and can impose a stay on creditor actions. Each route involves trade-offs in cost, speed, certainty and how much control management keeps.

Question 36

What is the purpose of a debt covenant waiver or amendment?

Accepted Answer

A waiver or amendment lets lenders relax a covenant that a borrower has breached or expects to breach. Lenders usually require fees, higher interest margins, tighter reporting or added collateral in return. This can avoid default, though it often signals weakness to other stakeholders.

Question 37

What is a debt-for-equity swap and when is it used?

Accepted Answer

A debt-for-equity swap converts creditor claims into ownership of shares, reducing leverage and interest burden. Creditors accept equity when the restructured business may be worth more than in liquidation. It suits firms with viable operations but unsustainable debt, and it heavily dilutes existing owners.

Question 38

How do advisors prepare a company for a potential sale or capital raise?

Accepted Answer

Advisors begin by reviewing financial statements, earnings quality and key metrics before investors do. They then build a management presentation, a financial model and a data room with contracts, policies and customer information. Advisors also help refine the equity story, explaining the business's appeal, risks and use of proceeds.

Question 39

What is the role of a board's special committee in a conflicted transaction?

Accepted Answer

A special committee of independent directors oversees a transaction in which a controlling shareholder, manager or other insider has a conflict of interest. The committee hires its own advisors, negotiates on behalf of minority shareholders and evaluates fairness. This structure helps protect the process if the deal is later challenged.

Question 40

Why is engagement letter scope and conflict checking important for advisors?

Accepted Answer

An engagement letter defines the services, fees, responsibilities and termination terms, reducing misunderstandings about what the advisor will and will not deliver. Conflict checking identifies whether the firm already advises a counterparty, lender or competitor, which could compromise objectivity or breach confidentiality. Clear scope and conflict controls protect clients and advisors alike.

Corporate Finance Advisory Flashcards

1Foundations of advisory work

2Valuation methods and assumptions

3Capital structure and financing choices

4Mergers, acquisitions and deal process

5Restructuring and advisory engagements

Learning Resources