Course Content
Organizational Forms, Corporate Issuer Features, and Ownership
This is Reading 22 of CFA Level 1, Corporate Issuers, 2024 course. This reading consists of three LOSs, i.e.,: a. compare the organizational forms of businesses b. describe key features of corporate issuers c. compare publicly and privately owned corporate issuers
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LOS A: Compare the organizational forms of businesses.
LOS B: Describe key features of corporate issuers
LOS C: Compare publicly and privately owned corporate issuers
INTRODUCTION TO CORPORATE GOVERNANCE AND OTHER ESG CONSIDERATIONS
This chapter is covered under study session 10, reading 31 of the study materials as provided by the CFA Institute.
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Introduction
LOS A: Describe corporate governance
00:00
LOS B: Company’s Stakeholders
08:17
LOS C: Principal-Agent Relationship
08:13
LOS D: Stakeholder’s Management
02:39
LOS E: Mechanisms of Stakeholders Management
09:25
LOS F: Board of Directors and Committees
06:57
LOS G: Factors Affecting Stakeholders Relationship and Corporate Governance
04:43
LOS H: Risks of Poor Corporate Governance & Benefits of Corporate Governance
03:14
LOS I: Analysts’ Consideration
04:32
Factors Affecting Company & ESG Implementation Methods
05:00
USES OF CAPITAL
This chapter is covered under study session 9, reading 28 of the study materials as provided by the CFA Institute. After reading this chapter, the candidate should be able to: a. a describe the capital allocation process and basic principles of capital allocation; b. demonstrate the use of net present value (NPV) and internal rate of return (IRR) in allocating capital and describe the advantages and disadvantages of each method; c. describe expected relations among a company’s investments, company value, and share price; d. describe types of real options relevant to capital investment; e. describe common capital allocation pitfalls.
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Introduction
LOS A: Capital Budgeting Process
20:19
LOS B: NPV and IRR
19:58
LOS C: Company’s Investment, Value, and Share Price
06:42
LOS D: Real options
08:54
LOS E: Capital Allocation Pitfalls
05:42
Sources of Capital
This topic is covered under LOS 29 of study session 9. After reading this chapter, you should be able to: a. describe types of financing methods and considerations in their selection; b. describe primary and secondary sources of liquidity and factors that influence a company’s liquidity position; c. compare a company’s liquidity position with that of peer companies; d. evaluate choices of short-term funding.
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Corporate Financing Options
24:21
Sources and Factors That Influence Liquidity
10:28
Comparing Liquidity Position
08:23
Short Term Funding
06:59
Cost of Capital
This chapter is covered under study session 10, reading 30 of the study material as provided by the CFA institute. After reading this chapter, the candidate should be able to: a) calculate and interpret the weighted average cost of capital (WACC) of a company; b) describe how taxes affect the cost of capital from different capital sources; c) calculate and interpret the cost of debt capital using the yield-to-maturity approach and the debt-rating approach; d) calculate and interpret the cost of noncallable, nonconvertible preferred stock; e) calculate and interpret the cost of equity capital using the capital asset pricing model approach and the bond yield plus risk premium approach; f) explain and demonstrate beta estimation for public companies, thinly traded public companies, and nonpublic companies; g) explain and demonstrate the correct treatment of flotation costs.
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Introduction
LOS A: Weighted Average Cost of Capital
12:25
LOS B: The Effect of Taxes on Capital Budgeting Decision
08:33
LOS C: Calculating Cost of Debt
08:27
LOS D: Calculating Cost of Preferred Stock
04:01
LOS E: Calculating Cost of Common Equity
12:40
LOS F: Estimating Company & Project β (Beta)
11:16
LOS J: Country Risk
LOS K: Marginal Cost of Capital Schedule
LOS L: Floatation Cost
Measures of Leverage
This chapter is covered under study session 11, reading 34 of the study material as provided by the CFA institute. After reading this chapter, the candidate should be able to: a. Define and explain leverage, business risk, sales risk, operating risk, and financial risk and classify a risk, given a description. b. Calculate and interpret the degree of operating leverage, the degree of financial leverage, and the degree of total leverage. c. Analyze the effect of financial leverage on a company’s net income and return on equity. d. Calculate the breakeven quantity of sales and determine the company’s net income at various sales levels. e. Calculate and interpret the operating breakeven quantity of sales.
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Introduction
LOS A: Risk and Components of Risk
LOS B and C: Degree of Leverage
LOS D: Break-Even Points
Impact of Leverage on Bankruptcy
Working Capital Management
This chapter is covered under study session 11, reading 35 of the study material as provided by the CFA institute. After reading this chapter, the candidate should be able to: a. describe primary and secondary sources of liquidity and factors that influence a company’s liquidity position; b. compare a company’s liquidity measures with those of peer companies; c. evaluate the working capital effectiveness of a company based on its operating and cash conversion cycles, and compare the company’s effectiveness with that of peer companies; d. describe how different types of cash flows affect a company’s net daily cash position; e. calculate and interpret comparable yields on various securities, compare portfolio returns against a standard benchmark, and evaluate a company’s short-term investment policy guidelines; f. evaluate a company’s management of accounts receivable, inventory, and accounts payable over time and compared to peer companies; g. evaluate the choices of short-term funding available to a company and recommend a financing method. 
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Introduction
LOS A: Liquidity Management
LOS C: Cash Conversion Cycle
LOS D: Impact of Cash Flow on Net Daily Cash Position
LOS E: Yield, Returns, and Policies
LOS F: Accounts Receivables, Inventories & Accounts Payable
LOS G: Short Term Funding
Corporate Issuers

LOS F requires to:

EXPLAIN AND DEMONSTRATE BETA ESTIMATION FOR PUBLIC COMPANIES, THINLY TRADED PUBLIC COMPANIES, AND NONPUBLIC COMPANIES

 

Reading 30, LOS F, Corporate Issuers, CFA Level 1 -2022 Estimating company and project beta

1.  Regression Analysis

a.  Typically, beta is calculated/estimated using regression analysis.

b.  The beta is calculated by taking the historical return on a company’s stock and regressing it over the market return.

c.  The regression equation found as a result is:

Rit = ậ + β Rmt

d.  β is the estimate of the beta coefficient. It is sensitive to the following:

i.  length of the estimation period (higher the estimation period, lesser is the richness of data and value of beta estimated),

ii.  periodicity within the period (smaller the interval of each period used, the lesser is the standard error in the estimated beta),

iii.  the selection of an appropriate market index (i.e. Rmt) also affects the value of β,

iv.  use of a smoothening technique and adjustment for small-cap stocks.

e.  Beta is the measure of systematic risk, it is mainly affected by business risk and financial risk.

Reading 30, LOS F, Corporate Issuers, CFA Level 1 -2022 estimating company and project beta

Business risk of a company is the risk related to the uncertainty of revenues, referred to as sales risk (which in turn is impacted by the elasticity of demand, its cyclicality, and the industry structure), and the operating risk.
Financing risk on the risk of the inability of the company to service the debt obligations. It is dependent on the level of debts.

1.1. Adjusting Beta

Another important thing about this beta we calculated above is that it is raw and or unadjusted. And it needs to be adjusted because it tends to move towards the value one in a long run. When the value of beta is one, it would mean that the expected return on equity would be exactly equal to the expected market return. So, we must re-adjust the beta.

The adjusted beta is an estimate of a security’s future beta. It uses the historical data of the stock but assumes that a security’s beta moves toward the market average over time. It weights the historic raw beta and the market beta. And the formula for the same is:

Adjusted beta = (.67) * Raw beta + (.33) * 1.0

2.  Pure-Play Method

a.  The pure-play method involves using a comparable publically traded company’s beta and adjusting for financial leverage differences.

b.  The company so selected should have a similar business risk as to the project. There may be differences in the level of financial risk, which may be adjusted for the differences.

c.  While analyzing the returns on a project we are concerned with the beta of the project. And, if the comparable beta is unleveraged (does not have the elements of debt), then we adjust the same by re-levering to reflect the capital structure of the project.
The beta of the project (i.e. beta of the assets) is:

ꞵA = ꞵDWD + ꞵEWE

Where,

ΒD          = Beta of debt,

WD           = Weight of debt in the capital structure,

βE           = Beta of equity,

WE             = Weight of equity in the capital structure.

Also,

WD  = D/(D+E), and

WE  = E/(D+E)

Therefore, we can re-write our equation as:

ꞵA = ꞵD[D/(D+E)] + ꞵE[E/(D+E)]

If we also include the impact of taxes on the debt of the company, we get:

ꞵA = ꞵD[(1-t)D / {(1-t)D+E}] + ꞵE[E / {(1-t)D+E}]

The above equation is also known as Hamada’s Equation. And while writing Hamada’s equation we make an assumption that the beta of debt equals zero.
Therefore, we can re-write Hamada’s Equation as:

ꞵA =  ꞵE[E / {(1-t)D+E}]

If we now divide both numerator and denominator by E, we get:

ꞵA =  ꞵE[E/E / {(1-t)D/E+E/E}]

Or, we get the following equation for the comparable unleveraged beta:

ꞵA =  ꞵE[1 / {(1-t)D/E+1}]

Where,

D/E        = Comparable company’s debt equity ratio

T            = Comparable effective tax rate

βE           = Comparable company’s leveraged beta

βA           = Comparable company’s unleveraged beta

Thus, we can also re-write this equation as:

ꞵL =  ꞵU [{(1-t)D/E}+1]

Where,

D/E        = Comparable company’s debt equity ratio

T            = Comparable effective tax rate

βL           = Comparable company’s leveraged beta

βU           = Comparable company’s unleveraged beta

If we present this equation graphically, we get the following graph:

Reading 30, LOS F, Corporate Issuers, CFA Level 1 -2022 estimating equity risk premium

In the above graph, the level of risk till the time debt is equal to zero, represents the premium for business risk, as there is no leverage till that time. But as there is an increase in the amount of leverage, the increase in the amount of risk that follows represents the premium for financial risk.

Thus, to sum up, we can say that the pre-play method of estimating beta involves the following steps:

Reading 30, LOS F, Corporate Issuers, CFA Level 1 -2022 pure play method of estimating beta

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