Another Sample Final exam -- Advanced Corporate Finance

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Date Posted: 13:04:58 04/19/01 Thu
Author: Charles Hodges
Subject: Another Sample Final exam

Exam 3 FI4300 Spring 2000 Your Name ___________________________

Instructions:
* True/False questions are worth 2 points. Multiple choice questions are worth 3 points. Short answer questions usually take less than three sentences and are worth 4 points. Problems are worth the number of points listed in the question. Other questions are valued as listed. Underline denotes a wording change from a previous quiz or exam.

TF1. According to the text, the primary goal for a firm's financial managers is to maximize shareholder's wealth.
a. True b. False

TF2. The optimal dividend policy is the long-run residual policy.
a. True b. False

TF3. In perfect capital markets, the way a firm finances its assets is irrelevant.
a. True b. False

TF4. When a low P/E firm acquires a high P/E firm, we generally expect the low P/E firm's earning per share to decrease.
a. True b. False

TF5. Financial Leverage is more controllable than Operating Leverage.
a. True b. False

SA1 . (2 points each)Real Options - fill in the blanks. If you need to describe the option more fully, write your description near the question. For the record, the type of option is either call or put. The underlying asset refers to the item, which upon a change in value, will impact the decision to exercise or not exercise the option.

a. Common stock where all stock is owned by an owner/manager.

Type of option ______ Who is long _________ Who is short ___________ Underlying Asset _________

b. Decision on Test marketing a product prior to a national ad campaign and product roll out.

Type of option ______ Who is long _________ Who is short ___________ Underlying Asset _________

c. Use of an efficient specialized machines with no salvage value versus a less-efficient general machine with large salvage value.

Type of option ______ Who is long _________ Who is short ___________ Underlying Asset _________

MC1. Two investment opportunities have the same total cash flows. This means that with a discount rate of 0%, their cash flows have the same sum. Choose the combination from the following three aspects of capital budgeting that will give the highest Internal Rate of Return (hint, change each of the aspects one at a time, assume the projects are identical except for this change). CHOOSE THE BEST ANSWER.

Payback Period Depreciation (to 0 salvage value) Cost of Financing
1. shortest 4. straight line 7. high cost
2. longest 5. MACRS 8. low cost
3. doesn't matter 6. doesn't matter 9. doesn't matter

a. 3, 6, 9. b. 1, 5, 8. c. 1, 5, 9.
d. 2, 4, 7. e. 3, 4, 7. f. 2, 6, 8.

MC2. For a normal, above-average risk (by any measure) capital budgeting project, the Net Present Value criteria assumes that expected future cash flows are reinvested at ___________, and the Payback Period criteria assumes that expected future cash flows are reinvested at ___________.
(a) A rate above the firm's weighted average cost of capital, no discount rate is used.
(b) A rate above the firm?s weighted average cost of capital, the accounting rate of return.
(c) The internal rate of return, the a rate below the firm's weighted average cost of capital.
(d) The firm's weighted average cost of capital, The accounting rate of return,.
(e) The accounting rate of return, the accounting rate of return.
(e) Neither criteria assumes reinvestment of future cash flows.

MC3.. Which of the following is considered the most important responsibility of the financial managers of a corporation?
a. liquidity management b. operations management c. capital budgeting
d. capital structure e. dividend policy

SA2. Briefly describe the set-of-contracts model of the corporation?

SA3. What is meant by the term "moral hazard"?

MC4. For an all equity firm, investments with NPV=$0:
a. typically have postive accounting profits.
b. are generally high risk.
c. will generally have low discount rates.
d. all of the above.
e. none of the above.

MC5. ___________ markets deal in securities with maturities of one year or more; ___________ markets deal with markets in which most new securities have fixed maturities.
a. money, primary b. capital, equity
c. spot, derivative d. futures, debt
e. none of the above.

MC6. For a long-term capital budgeting project, expensing an item rather than capitalizing an item will most likely not affect the project's total net income over the life of the project. However, expensing the item will reduce the project's calculated Payback Period and Internal Rate of Return.
a. True B. False

MC7. For a typical firm with a given capital structure, which of the following is correct? (Note: All rates are after taxes.)
a. kd > ks > WACC. b. ks > kd > WACC.
c. WACC > ks > kd. d. ks > WACC > kd.
e. None of the statements above is correct.

SA4. (6 points) An all-equity firm with 10,000 shares is currently selling for $20 per share. The firm has $30,000 available to pay dividends or repurchase stock. This is a no-tax world and no information is revealed by the dividend payment method. Fill in the blanks below.

Before the cash is distributed
Assets = _______ Debt= _______ Equity=________ Price per share=________

After paying $30,000 in dividends
Assets = ________ Debt= _________ Equity=_________ Price per share=________

After $30,000 in share repurchases
Assets = ________ Debt= _________ Equity=_________ Price per share=________

SA5. What is the optimal capital structure? Why?

TF6. In the real world, the expected value of bankruptcy costs is negatively related to the degree of specialization of the firm's assets.
A. True B. False

TF7. For most companies, dividends are less stable than earnings.
A. True B. False

SA 6. (2 points) Match the term with the date:
Record Date _________ May 12, 1999
Payment Date __________ May 15, 1999
Ex-Dividend Date __________ May 30, 1999
Declaration Date _________ May 5, 1999

PROBLEM INSTRUCTIONS

* Show all work.
* Be sure to label each section of the answer.
* Use the back of the test if you need more room.
* Set your calculator to four decimal places.

1. (8 points) Rollins Corporation is constructing its MCC schedule. The firm is at its target capital structure. Its bonds have a 9 percent coupon, paid semiannually, a current maturity of 17 years, and sell for $1,210. Rollins' beta is 1.1, the risk-free rate is 6 percent, and the expected return on the market is 12 percent. Rollins is a constant growth firm, which just paid a dividend of $1.5, sells for $25.00 per share, and has a growth rate of 12 percent.
The firm's book value balance sheet is as follows:
Asset $15,650 Long Term Debt $15,000
Equity ($.25 par) $600
Retained Earnings $50

What is the firm's leverage ratio?

What is Rollins' cost of debt%?

What is Rollins' cost of retained earnings using the Discounted Cash Flow approach?

Using your DCF estimate of the cost of retained earnings, what is Rollins' WACC?

2. (7 points) Two firms plan to merge. There are no synergies, acquisition expenses and no premium is being paid. Prior to the merger, the acquirer has earnings per share of $2 and a price earnings ratio of 25. The acquiree has earnings per share of $6 a price earnings ratio of 10. The acquiror has 10 million shares of stock and the acquiree has 7 million shares of stock. What is the acquirer's market value, earnings per share, and Price-earnings ratio after the acquisition?

4. (2 points) Your required rate of return is 10%. If you invest $150 today you will receive the following cash flows:
At the end of year 1 $90
At the end of year 2 $35
At the end of year 3 $40
What is the Profitability Index of the project?

5. (10 points) Parker Products manufactures a variety of household products. The company is considering introducing a new detergent. The company's CFO has collected the following information about the proposed product. (Note: You may or may not need to use all of this information, use only the information that is relevant.)

a. The project has an anticipated economic life of 4 years. To assess the demand for the new product, last year the company conducted a marketing survey that cost $60,000.
b. The company will have to purchase a new machine to produce the detergent. The machine has an up-front cost (t = 0) of $2 million. The machine will be depreciated on a straight-line basis over 4 years (that is, the company's depreciation expense will be $500,000 in each of the first four years (t = 1, 2, 3, and 4).) The company anticipates that the machine will last for four years, and that after four years, its salvage value will equal $0.
c. If the company goes ahead with the proposed product, it will have an effect on the company's net working capital. At the outset, t = 0, inventory will decrease by $150,000 and accounts payable will increase by $80,000. At t = 4, the net working capital will be recovered after the project is completed.
d. The detergent is expected to generate sales revenue of $2 million in each year. Each year the operating costs (not including depreciation) are expected to equal 50 percent of sales revenue.
e. If the project is accepted, the company's interest expense each year will be $100,000, however dividends will be reduced by $50,000.
f. The new detergent is expected to reduce the before-tax cash flows of the company's existing products by $250,000 a year (t = 1, 2, 3, and 4).
g. The proposed project is riskier than the average project for Parker; the project's Cost of Capital is estimated to be 12 percent.
h. The company's tax rate is 40 percent.

What is the net present value of the proposed project?

Exam 3 FI4300 Spring 2000 Your Name ___________________________
Open Book, Open Notes. Point Values are as shown.

5. (7.5 points) Deliman Chicken has the the following balance sheet; Assets 4000 = Debt 1000 plus Equity 3000. The firm is, zero-growth firm with 50 shares selling for $60 each. The firm pays no taxes and pays out all earnings as dividends. The firm's debt is selling at par and has a coupon rate of 8%. Last year the firm's EBIT was $425.

a. Under the current capital structure, what is the WACC?

b. What is the current market value of the firm?

Now assume the firm issues $1000 of equity to repurcahse all of the outsstanding debt.

c. What is the firm's new WACC?

d. What is the firm's new Dividends per share?

e. What is the firm's new cost of common equity(%)?

1. (4.5 points) In 1998, the Lissa Company, a low growth firm, paid dividends of $2,000,000 on after-tax income (cash flow) of $26,000,000. Capital budget projects totaled $4,000,000 in 1998. 1998 was a normal year for earnings, dividends, and capital budgets. For the past 8 years, earning have grown at a constant rate of 5%. However, in 1999, earnings are expected to fall to $22,000,000 and the firm expects to have profitable investment opportunities will grow to 8,000,000. It is predicted that Lissa will not maintain the 1998 level of earnings growth, and the company will return to it previous 5% growth rate. Lissa's target debt ratio is 20%.

a. Calculate Lissa's total dividends for 1998 if its dividend payment is set to force dividends to grow at the long-run growth rate in earnings.

b. Calculate Lissa's total dividends for 1998 if it continues its 1997 dividend payout ratio.

c. Calculate Lissa's total dividends for 1998 if it uses a pure residual dividend.

3. Now consider a COMPANY in a world that of perfect capital markets, with one change, CORPORATE TAXES DO EXIST. This world has no personal taxes, all investors have homogeneous expectations, no bankruptcy costs, and M&M's with corporate taxes theory of capital structure is true. Company Y is financed has the following market value balance sheet:

Assets = $ 185 Liabilities = $90
Equity = $95

The firm had $30 in EBIT last year. The firm has 19 shares outstanding. The firm expects the same return/profits for the foreseeable future. The firm a is a zero growth firm, that pays out all excess earnings as dividends. Any time the firm changes its capital structure, it changes only the debt/equity mix and does not change its total assets. Liabilities consist only of the firm's debt. The debt is riskless, perpetual, selling at par, and has a 7% pre-tax yield. If the firm were to change its capital structure, new debt would still have a 7% pre-tax yield. The firm's tax rate is 35%. Given this information, answer the following questions:

a. (2 points) What is the value of the firm's tax shield due to the use of perpetual debt?

b. (2 points) What is the current expected return on the firm's equity?

c. (2 points) Now suppose that two things happen. Assume that the pre-tax yield on debt increases to 9%, and suppose the firm decides to issue an additional $20 in debt. What is the value of the tax shield associated with this new debt?

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Replies:

Re: Another Sample Final exam -- aanda ada, 15:55:42 12/08/07 Sat
Re: Another Sample Final exam -- Esther Wong, 18:19:48 01/19/14 Sun