Analyzes in Corporate Finance

Analyzes in Corporate Finance

Compare these characteristics with the past policy of the company and analyze their evolution over time.

Compare with the average rate of similar companies

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Dividends policy

Analyzing
-> indicate the profitability of the company
-> part of the communication strategy of the company towards its shareholders

Assess
- Amount of dividends paid
- Payout ratio: Div/Net Income
// Level of dividends distributed as compared to the business capacities: weak, moderate, high
- Distribution rate: Div/EPS
- Dividends distribution’s tendency: constant or variable (variation of % if any)

Resolve
Governance mechanism: disciplining managers by forcing them to integrate the interests of shareholders in their reasoning

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PBR
PER
-> If they are high -> good time to issue equity

Leverage rate
Even if the firm has little risk, the problem here is that it is very highly levered.

Hence, equity is risky, and the probability of financial distress is high.

EPS

EPS and firm value are two different concepts.

• You can increase firm value while reducing EPS at the same time.

• or you can reduce value while increasing EPS (for instance when the firm is too highly levered).

When you reduce leverage, EPS (and ROE) go down, but that’s because risk is reduced.

Cost of debt and cost of equity
The evolution of the cost of debt, and that of the cost of equity, will depend on the one hand on the evolution of the risk of capital employed and on the other hand on the way in which the risk is shared between creditors and shareholders.

There are significant costs of financial distress if the debt increases (in particular debt overhang: the firm will not be able to take advantage of growth opportunities because it already has too much debt).

The cost of debt should reduce if the operation will enable the company to deleverage and accordingly to its creditors to reduce their exposure to the risk of capital employed.

Similarly, the cost of equity should decrease as the operation will enable the company to deleverage and thus to reduce the risk linked to the debt carried by the shareholders.

For the exam, please make sure you specify the formula you are using and make the explanation based on the components of the formula so that it justifies your reasoning beyond simple memorization of the « good » or « bad » number whether positive or negative.

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