FIN-510 Advanced Corporate Finance

Student
First Name Last Name

I. Short-Answer Questions (3 Points Each)

1. What has caused the agency problem in public corporations?

2. What are the disadvantages of the Payback Period method?

3. Please list four reasons why companies want to go public.

4. Why capital structure does not impact firm value if there is no tax or friction in
the financial markets?

II. Definitions (3 Points Each)

1. Annuity 2. Yield to Maturity 3. WACC 4. Rights Issue

III. True () or False () (2 Points Each)

1. For a given nominal annual interest rate, the higher the frequency of
compounding, the larger the future value.
2. For a given bond, the higher the required rate of return, the lower the price the
investors are willing to pay.
3. Preferred stock takes priority over common stock when receiving dividends.

4. Bonds issued by companies are considered debt. Accounts Payable are also
considered debt.

5. Shelf Registration allows companies to file one registration statement for several
issues of same security in the following three years.

IV. Mathematical Problems

1. Given a quarterly rate of 3.5%, what is the EAR? What is the APR? (5 Points)

2. In January 2014 you purchase a four-year U.S. government bond with a face value
of $1,000. The bond has an annual coupon rate of 5%, paid semiannually. If you demand
a 3.45% semiannual return, what is the price of the bond? (6 Points)
 3. Suppose that you buy a 3-year 10% corporate bond at its face value. What is your
nominal return over the three years if inflation is 3.5% in the 1 st year, 4.2% in the 2 nd
year, and 5.1% in the 3rd year? What will be your real return? (5 Points)

4. Company BW will pay dividends of $1.25, $1.08, and $2.01 over next three years
(dividend will be paid at the end of each year). You are expecting the stock price to be
$24.58 right after the company pays the 3rd dividend. What is the maximum price you
are willing to pay for this stock if your annual required rate of return is 9.5%? (5
Points)

5. (1) Our company has issued $2,000 bonds with an annual coupon rate of 4%. If
the marginal corporate income tax is 15%, what is our cost of debt? (3 Points)

(2) Our company has also issued $5,000 preferred stock. The face value is $100,
and coupon rate is 6%, and market pays $105 for a share. What is the cost of preferred
stock? (4 Points)

(3) Five years ago we issued 1,000 common stock with an issue price of $18 per
share. Analysts find out the current Beta of our company is 1.78. What is the cost of
equity if current T-bill rate is 2.35% and expected return on the market portfolio this
year is 7%? (4 Points)

(4) Find the overall cost of capital for our company. (6 Points)

(5) Suppose our company has the following three investment opportunities.
According to the weighted average Profitability Index, we should choose which
project(s) if we have only $8600 to invest? (12 Points)

Year Project A Project B Project C

0 -3000 -4800 -7000
1 650 1900 2200
2 800 2400 2700
3 750 2180 3600
4 920 2610 3200

6. The current market price of company BWs stock is $48 per share. BW decides
to raise additional funds via a 2 for 10 rights offer at $35 per share. If we assume 100%
subscription, what is the value of each right? (8 Points)

V. Theory Questions
1. Please explain the Expectations Theory. (8 Points)