FIN 516 FINAL EXAM
FIN 516
FIN 516 FINAL
FIN 516 FINAL EXAM
1. (TCO B) Which of the following statements concerning the MM extension with growth is
... [Show More] NOT CORRECT?
(a) The tax shields should be discounted at the unlevered cost of equity.]
(b) The value of a growing tax shield is greater than the value of a constant tax shield.
(c) For a given D/S, the levered cost of equity is greater than the levered cost of equity under MM’s original (with tax) assumptions.
(d) For a given D/S, the WACC is greater than the WACC under MM’s original (with tax) assumptions.
(e) The total value of the firm is independent of the amount of debt it uses.
Question 2.2. (TCO D) Which of the following statements is most correct?
(a) In a private placement, securities are sold to private (individual) investors rather than to institutions.
(b) Private placements occur most frequently with stocks, but bonds can also be sold in a private placement.
(c) Private placements are convenient for issuers, but the convenience is offset by higher flotation costs.
(d) The SEC requires that all private placements be handled by a registered investment banker.
(e) Private placements can generally bring in funds faster than is the case with public offerings. (Points : 20)
2. (TCO D) Which of the following is generally NOT true and an advantage of going public?
(a) Facilitates stockholder diversification.
(b) Increases the liquidity of the firm's stock.
(c) Makes it easier to obtain new equity capital.
(d) Establishes a market value for the firm.
(e) Makes it easier for owner-managers to engage in profitable self-dealings.
Question 3.3. (TCO E) Buster’s Beverages is negotiating a lease on a new piece of equipment that would cost $100,000 if purchased. The equipment falls into the MACRS 3-year class, and it would be used for 3 years and then sold, because the firm plans to move to a new facility at that time. The estimated value of the equipment after 3 years is $30,000. If the borrow and purchase option is used, the cash flows would be the following: (Year 1) -2,400; (Year 2) -3,800; (Year 3) -1,400; (Year 4) -79,600; all of these cash outflows would be at the beginning of the respective years. Alternatively, the firm could lease the equipment for 3 years, with annual lease payments of $29,000 per year, payable at the beginning of each year. The firm is in the 20% tax bracket. If it borrows and purchases, it could obtain a 3-year simple interest loan, to purchase the equipment at a before-tax interest rate of 10%. If there is a positive net advantage to leasing, the firm will lease the equipment. Otherwise, it will buy it. What is the NAL?
(a) $5,736
(b) $6,023
(c) $6,324
(d) $6,640
(e) $6,972 (Points : 20)
Life of equipment: 3 Tax rate: 20%
Loan amount = equipment cost: $100,000 Maintenance costs: $3,000
Interest rate, simple: 10.0% Salvage value: $30,000
Lease Pmt: $29,000
Loan Analysis: 0 1 2 3 Totals
MACRS factor 0.33 0.45 0.15 0.93
Depreciation 33,000 45,000 15,000 93,000
Loan repayment -100,000
Interest -10,000 -10,000 -10,000
Int tax saving (Interest T)) 2,000 2,000 2,000
Maintenance -3,000 -3,000 -3,000
Maint. tax saving (Maint. T) 600 600 600
Depr'n tax saving (Deprn T) 6,600 9,000 3,000
Net operating CF -2,400 -3,800 -1,400 -105,000
Salvage value before taxes 30,000
Book value (Cost − Total dep'rn) 7,000
Taxable salvage value 23,000
Tax on salvage value -4,600
Salvage value after taxes 25,400
Total Net CF - 2,400 -3,800 -1,400 -79,600
PV cost at I(1 − T) = 8.00% -70,308
Lease Analysis: 0 1 2 3
Lease payment -29,000 -29,000 -29,000
Tax saving on pmt 5,800 5,800 5,800 0
Net cost of lease -23,200 -23,200 -23,200 0
PV cost of leasing at I(1 − T) -64,572
NAL = $5,736
3. (TCO E) Dakota Trucking Company (DTC) is evaluating a potential lease for a truck with a 4-year life that costs $40,000 and falls into the MACRS 3-year class. If the firm borrows and buys the truck, the loan rate would be 10%, and the loan would be amortized over the truck's 4-year life. The loan payments would be made at the end of each year. The truck will be used for 4 years, at the end of which time it will be sold at an estimated residual value of $10,000. If DTC buys the truck, its after tax cash flows would be the following: (Year 1) - 6,339; (Year 2) -4,764; (Year 3)-9,943; (Year 4) -5,640; all occurring at the end of respective years. The lease terms, call for a $10,000 lease payment (4 payments total) at the beginning of each year. DTC's tax rate is 40%. Should the firm lease or buy?
(a) $849
(b) $896
(c) $945
(d) $997
(e) $1,047
Life of equipment: 4 Tax rate: 40%
Loan amount = equipment cost: $40,000 Maintenance costs: $1,000
Interest rate: 10.0% Salvage value: $10,000
Lease Pmt: $10,000
Loan amortization for cash payment and interest expense:
Payment: N = 4, I/YR = 10, PV = 40000, FV = 0. PMT = -$12,618.83
Year Beg. Bal. PMT Interest Principal Ending Bal.
1 40,000 12,619 4,000 8,619 31,381
2 31,381 12,619 3,138 9,481 21,900
3 21,900 12,619 2,190 10,429 11,472
4 11,472 12,619 1,147 11,472 0
Loan Analysis: 0 1 2 3 4
MACRS factor 0.33 0.45 0.15 0.07
Depreciation 13,200 18,000 6,000 2,800
Loan Pmt -12,619 -12,619 -12,619 -12,619
Int tax saving (Int. from table T)) 1,600 1,255 876 459
Maintenance -1,000 -1,000 -1,000 -1,000
Maint. tax saving (Maint. T) 400 400 400 400
Depr'n tax saving (Deprn T) 5,280 7,200 2,400 1,120
Net operating CF -6,339 -4,764 -9,943 -11,640
Salvage value 10,000
Tax on residual -4,000
Net residual val 6,000
Total Net CF -6,339 -4,764 -9,943 -5,640
PV cost of buying at I(1 – T) = 6.00% -23,035
Lease Analysis: 0 1 2 3 4
Lease payment -10,000 -10,000 -10,000 -10,000 0
Tax saving on pmt 4,000 4,000 4,000 4,000 0
Net cost of lease -6,000 -6,000 -6,000 -6,000 0
PV cost of leasing at I(1 – T) -22,038
NAL = $997
4. (TCO I) Suppose 90-day investments in Britain have a 6% annualized return and a 1.5% quarterly (90-day) return. In the U.S., 90-day investments of similar risk have a 4% annualized return and a 1% quarterly (90-day) return. In the 90-day forward market, 1 British pound equals $1.65. If interest rate parity holds, what is the spot exchange rate?
(a) 1 pound = $1.8000
(b) 1 pound = $1.6582
(c) 1 pound = $1.0000
(d) 1 pound = $0.8500
(e) 1 pound = $0.6031 (Points : 20)
From the interest rate parity formula it follows that
e0 = (ft)(1 + rf)/(1 + rh) = (1.65 dollars/pound)(1.015)/(1.01) = 1.6582 dollars/pound.
$1.65 x (1 + 0.015) / (1 + 0.01) = 1.67475 / 1.01 = $1.6582
4. (TCO I) Suppose in the spot market 1 U.S. dollar equals 1.60 Canadian dollars. 6-month Canadian securities have an annualized return of 6% (and thus a 6-month periodic return of 3%). 6-month U.S. securities have an annualized return of 6.5% and a periodic return of 3.25%. If interest rate parity holds, what is the U.S. dollar-Canadian dollar exchange rate in the 180-day forward market?
(a) 1 U.S. dollar = 0.6235 Canadian dollars
(b) 1 U.S. dollar = 0.6265 Canadian dollars
(c) 1 U.S. dollar = 1.0000 Canadian dollars
(d) 1 U.S. dollar = 1.5961 Canadian dollars
(e) 1 U.S. dollar = 1.6039 Canadian dollars
1 U.S. dollar = 1.5961 Canadian dollars
The difference between securities return for 6 month is (3.25% - 3%) = 0.25%
100%-0.25%=99,75% or 0,9975
So, the exchange rate will be: 1.6*0.9975 = 1.5961
Question 4.4. (TCO I) Suppose hockey skates sell in Canada for 105 Canadian dollars, and 1 Canadian dollar equals 0.71 U.S. dollars. If purchasing power parity (PPP) holds, what is the price of hockey skates in the United States?
(a) $14.79
(b) $63.00
(c) $74.55
(d) $85.88
(e) $147.88 (Points : 20)
Price of skates, C$105.00 C$
Spot exchange rate, $/C$$0.71P
Ph =Pf × Spot rate
Ph = 105.00 × $0.71=74.55
5. (TCO C) Dentaltech Inc. projects the following data for the coming year. If the firm follows the residual dividend policy and also maintains its target capital structure, what will its payout ratio be?
EBIT $2,000,000
Capital budget $850,000
Interest rate 10%
% Debt 40%
Debt outstanding $5,000,000
% Equity 60%
Shares outstanding $5,000,000
Tax rate 40%
(a) 37.2%
(b) 39.1%
(c) 41.2%
(d) 43.3%
(e) 45.5% (Points : 20)
EBIT $2,000,000 Capital budget $850,000
Interest rate 10% % Debt 40%
Debt outstanding $5,000,000 % Equity 60%
Shares outstanding $5,000,000 Tax rate 40%
EBIT $2,000,000
− Interest expense = interest rate × debt 500,000
Taxable income $1,500,000
− Taxes = Tax rate × income 600,000
Net income (NI) $900,000
− Equity needed for capital budget = % Equity(capital budget) = 510,000
Dividends = NI − Equity needed $390,000
Payout ratio = Dividends/NI 43.33%
5. (TCO C) D. Paul Inc. forecasts a capital budget of $725,000. The CFO wants to maintain a target capital structure of 45% debt and 55% equity, and it also wants to pay dividends of $500,000. If the company follows the residual dividend policy, how much income must it earn, and what will its dividend payout ratio be?
Net Income Payout
(a) $898,750 55.63%
(b) $943,688 58.41%
(c) $990,872 61.43%
(d) $1,040,415 64.40%
(e) $1,092,436 67.62%
Residual model--find NI, then divs and payout
Capital budget $725,000
Equity ratio 55%
Dividends paid $500,000
NI=Divs + (Eq % × Cap Bud) $898,750
Payout = Dividends/NI 55.63%
6. (TCO F) Warren Corporation’s stock sells for $42 per share. The company wants to sell some 20-year, annual interest, $1,000 par value bonds. Each bond would have 75 warrants attached to it, each exercisable into one share of stock at an exercise price of $47. The firm’s straight bonds yield 10%. Each warrant is expected to have a market value of $2.00 given that the stock sells for $42. What coupon interest rate must the company set on the bonds in order to sell the bonds-with-warrants at par?
(a) 7.83%
(b) 8.24%
(c) 8.65%
(d) 9.08%
(e) 9.54% (Points : 20)
N =20 Years
Warrants =$2*75
=$150
Interest =10%
Face value =$1000
Present Value =$1000-$150 =$850
$850 =PMT {PVFA10, 20} +FV {PV10, 20}
850 = PMT (8.514) +1000(.149)
850 =PMT (8.514) +149
850-149 =PMT (8.514)
701 =PMT (8.514)
PMT =701/8.514
=$82.34
Rate =$82.34/1000*100
=8.24%
Rate =8.24%
7. (TCO B) Reynolds Resorts is currently 100% equity financed. The CFO is considering a recapitalization plan under which the firm would issue long-term debt with a yield of 9% and use the proceeds to repurchase common stock. The recapitalization would not change the company’s total assets, nor would it affect the firm’s basic earning power, which is currently 15%. The CFO believes that this recapitalization would reduce the WACC and increase stock price. Which of the following would also be likely to occur if the company goes ahead with the recapitalization plan?
(a) The company’s net income would increase.
(b) The company’s earnings per share would decline.
(c) The company’s cost of equity would increase.
(d) The company’s ROA would increase.
(e) The company’s ROE would decline. (Points : 20)
8. (TCO G) Which of the following statements is most correct?
(a) Our bankruptcy laws were enacted in the 1800s, revised in the 1930s, and have remained unaltered since that time.
(b) Federal bankruptcy law deals only with corporate bankruptcies. Municipal and personal bankruptcy are governed solely by state laws.
(c) All bankruptcy petitions are filed by creditors seeking to protect their claims against firms in financial distress. Thus, all bankruptcy petitions are involuntary as viewed from the perspective of the firm’s management.
(d) Chapters 11 and 7 are the most important bankruptcy chapters for financial management purposes. If a reorganization plan cannot be worked out under Chapter 11, then the company will be liquidated as prescribed in Chapter 7 of the Act.
(e) Restructuring a firm’s debt can involve forgiving a certain portion of the debt, but it cannot call for changing the debt’s maturity or its contractual interest rate. (Points : 20)
8. (TCO G) Chapter 7 of the Bankruptcy Act is designed to do which of the following?
(a) Protect shareholders against creditors.
(b) Establish the rules of reorganization for firms with projected cash flows that eventually will be sufficient to meet debt payments. (c) Ensure that the firm is viable after emerging from bankruptcy.
(d) Allow the firm to negotiate with each creditor individually.
(e) Provide safeguards against the withdrawal of assets by the owners of the bankrupt firm and allow insolvent debtors to discharge all of their obligations and to start over unhampered by a burden of prior debt.
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9.TCO I) In 1985, a given Japanese imported automobile sold for 1,476,000 yen, or $8,200. If the car still sold for the same amount of yen today but the current exchange rate is 144 yen per dollar, what would the car be selling for today in U.S. dollars?
(a) $5.964
(b) $8,200
(c) $10,250
(d) $12,628
(e) $13,525 (Points : 20)
Suppose one British pound can purchase 1.82 U.S. dollars today in the foreign exchange market, and currency forecasters predict that the U.S. dollar will depreciate by 12.0% against the pound over the next 30 days. How many dollars will a pound buy in 30 days?
(a) 1.12
(b) 1.63
(c) 1.82
(d) 2.04
(e) 3.64
The answer is D
British pound $1.82
Dollar depreciation 12.00%
The British pound will appreciate against the dollar by 12.00%
British pound = $/£ × (1 + % $ depreciation)
British pound = 1.82 x (1 + 0.12) = $2.0384
10. (TCO H) Which of the following statements is most correct?
(a) The acquiring firm’s required rate of return in most horizontal mergers will not be affected, because the two firms will have similar betas.
(b) Financial theory says that the choice of how to pay for a merger is really irrelevant because although it may affect the firm’s capital structure, it will not affect its overall required rate of return.
(c) The basic rationale for any financial merger is synergy, and thus, the estimation of pro-forma cash flows is the single most important part of the analysis.
(d) In most mergers, the benefits of synergy and the premium the acquirer pays over the market price are summed and then divided equally between the shareholders of the acquiring and target firms.
(e) The primary rationale for most operating mergers is synergy. (Points : 20)
10. (TCO H) Which of the following statements about valuing a firm using the APV approach is most CORRECT?
(a) The horizon value is calculated by discounting the free cash flows beyond the horizon date and any tax savings at the levered cost of equity. (b) The horizon value is calculated by discounting the free cash flows beyond the horizon date and any tax savings at the cost of debt. (c) The horizon value is calculated by discounting the expected earnings at the WACC.
(d) The horizon value is calculated by discounting the free cash flows beyond the horizon date and any tax savings at the WACC.
(e) The horizon value must always be more than 20 years in the future.
11. (TCO A) An investor who writes standard call options against stock held in his or her portfolio is said to be selling what type of options?
(a) In-the-money
(b) Put
(c) Naked
(d) Covered
(e) Out-of-the-money (Points : 20)
11. (TCO A) Call options on XYZ Corporation's common stock trade in the market. Which of the following statements is most correct, holding other things constant?
(a) The price of these call options is likely to rise if XYZ's stock price rises.
(b) The higher the strike price on XYZ's options, the higher the option's price will be.
(c) Assuming the same strike price, an XYZ call option that expires in one month will sell at a higher price than one that expires in three months. (d) If XYZ's stock price stabilizes (becomes less volatile), then the price of its options will increase.
(e) If XYZ pays a dividend, then its option holders will not receive a cash payment, but the strike price of the option will be reduced by the amount of the dividend.
12. (TCO F) A swap is a method used to reduce financial risk. Which of the following statements about swaps, if any, is not correct?
(a) A swap involves the exchange of cash payment obligations.
(b) The earliest swaps were currency swaps in which companies traded debt denominated in different currencies, say dollars and pounds.
(c) Swaps are very often arranged by a financial intermediary, who may or may not take the position of one of the counterparties.
(d) A problem with swaps is that no standardized contracts exist, which has prevented the development of a secondary market.
(e) A company can swap fixed interest payments for floating interest payments. (Points : 20)
12. (TCO F) Which of the following statements is most CORRECT?
(a) One advantage of forward contracts is that they are default free.
(b) Futures contracts generally trade on an organized exchange and are marked to market daily.
(c) Goods are never delivered under forward contracts, but are almost always delivered under futures contracts.
(d) There are futures contracts for currencies but no forward contracts for currencies.
(e) Futures contracts don't have any margin requirements but forward contracts do. [Show Less]