Korteweg FBE 432: Corporate Financial Strategy Spring 2018

FBE 432: Corporate Financial Strategy

Spring 2018

Name

Midterm Exam

o Please check that the exam version matches the version on your bubble sheet!!
o You are allowed to use books and written notes, but you are NOT allowed to use
computers, cellphones, or other electronic resources apart from a calculator, or enter
into ANY communication on the subject of this exam.
o Only one answer per question is correct.
o Each question is worth 10 points.
o There are 15 (fifteen) questions in this exam. Each question is 10 points, for a total
of 150 points. Please check to make sure you have considered and properly filled
out your bubble sheet for all questions before submitting your solution.
o Turn in both this exam and your bubble sheet.

Good Luck!

Page | 1 of 6
Korteweg FBE 432: Corporate Financial Strategy Spring 2018

Question 1
You want to estimate a company’s Enterprise Value (EV), based on comparable firms’ EV/EBIT
multiple. You believe the following three firms are all reasonably comparable:
Comparable firm A Comparable firm B Comparable firm C
EV/EBIT 11 15 13
Based on EBIT of $2 million, what is your best estimate for the company’s EV?
A. $6.5 million.
B. $22 million.
C. $26 million.
D. $30 million.

Question 2
A firm has an enterprise value of $100 million. It has debt equal to $40 million, and $5 million in
excess cash. The market value of equity of the firm is closest to:
A. $55 million.
B. $65 million.
C. $135 million.
D. $140 million.

Question 3
Suppose a firm is financed only with equity (that is, without debt or other securities besides
common equity). The company has some excess cash. Which statement is correct?
A. The firm’s equity beta is lower than its asset beta.
B. The firm’s equity beta is equal to its asset beta.
C. The firm’s equity beta is higher than its asset beta.
D. The firm’s equity beta could be higher or lower than its asset beta.

Question 4
A firm has a debt beta of 0.25. The rate on U.S. Treasuries is 4% per year for all maturities, and
the market risk premium, E(Rm)-Rf, is 6%. The expected rate of return on debt for this firm is
closest to:
A. 2.5% per year.
B. 5.5% per year.
C. 6.5% per year.
D. 10% per year.

Page | 2 of 6
Korteweg FBE 432: Corporate Financial Strategy Spring 2018

Question 5
A firm has made the following purchases:
Month Purchase Amount
January $6,000
February $3,000
March $4,800
Suppose the monthly purchases occurred evenly over the month and the oldest purchases are
paid off first (that is, first-in-first-out). The average payables period is 35 days. Assuming all
months have 30 days, the cash paid for purchases in the month of March is closest to:
A. $3,500.
B. $4,000.
C. $4,500.
D. $5,500.

Question 6
Based on the information in the previous question, the balance of the accounts payable account
at the end of March is closest to:
A. $3,300.
B. $4,500.
C. $4,800.
D. $5,300.

Question 7
Suppose a company has a policy of targeting a leverage ratio of 35% (measured as the market
value of net debt divided by the sum of the market values of net debt and equity). The
company’s equity beta is 1.5, its debt beta is 0.1, and the company faces a 40% tax rate.
The company’s asset beta is closest to:
A. 0.975.
B. 0.996.
C. 1.01.
D. 1.6.

Question 8
Use the information in the previous question, and assume the risk-free rate is 4% (for all
maturities) and the market risk premium, E(Rm)-Rf, is 6%. The company’s weighted average
cost of capital (WACC) is closest to:
A. 9.29%.
B. 9.42%.
C. 10%.
D. 10.06%.

Page | 3 of 6
Korteweg FBE 432: Corporate Financial Strategy Spring 2018

Question 9
Consider the following selected (end-of-year) financial statement information:
2016 2017
Current Assets
Cash 650 750
Accounts receivable 4,875 5,200
Inventories 3,720 3,840
Long-term Assets
PP&E (net of depreciation) 7,880 8,420

Current Liabilities
Accounts payable 3,790 3,920

Long-term Liabilities
Bank notes payable 3,515 3,260
Deferred taxes 640 720

Income Statement
Depreciation 560 640
EBIT 2,861 3,165
Dividends 450 400

In constructing a Sources and Uses statement for the year 2017, which of the following
statements is correct?
A. Inventories was a use of funds, and Dividends was a source.
B. Both Inventories and Dividends were a source of funds.
C. Inventories was a source of funds, and Dividends was a use.
D. Both Inventories and Dividends were a use of funds.

Question 10
Use the financial information from the previous question to answer this question. Assuming all
cash is excess cash, the company’s book value of net debt at end-of-year 2017 is closest to:
A. 2,510.
B. 3,230.
C. 3,260.
D. 7,150.

Page | 4 of 6
Korteweg FBE 432: Corporate Financial Strategy Spring 2018

Question 11
Use the financial data in question 9 to answer this question. Assume all cash is excess cash.
When computing free cash flow for 2017, the change in Net Working Capital is closest to:
A. 315.
B. 415.
C. 5,120.
D. 5,817.

Question 12
Choose the correct answer: In computing the incremental free cash flows for a project, …
A. … positive externalities raise the incremental free cash flows.
B. … negative externalities raise the incremental free cash flows.
C. … opportunity costs should not be included in the incremental free cash flows.
D. … sunk costs should be included in the incremental free cash flows.

Question 13
A company plans to speed up collections on its customers’ outstanding bills. Assuming nothing
else changes, what happens to its cash-to-cash cycle?
A. The cash-to-cash cycle will increase.
B. The cash-to-cash cycle will decrease.
C. The cash-to-cash cycle will stay the same.
D. Cannot be determined from the information provided.

Question 14
Suppose the corporate tax rate is reduced. Assuming the company’s EBIT, depreciation, capital
expenditures and net working capital needs are not expected to change, what happens to the
company’s expected free cash flows?
A. Free cash flows are expected to increase.
B. Free cash flows are expected to decrease.
C. Free cash flows are expected to stay the same.
D. Cannot be determined from the information provided.

Question 15
A firm aims to keep a total amount of debt equal to $100 million. The expected rate of return on
debt is 5% per year, the firm’s tax rate is 30%, and there is no excess cash. The firm’s PV(TS),
the present value of the interest tax shield, is closest to:
A. $1.5 million.
B. $30 million.
C. $600 million.
D. Cannot be determined with the information provided.

Page | 5 of 6
Korteweg FBE 432: Corporate Financial Strategy Spring 2018

[END OF EXAM]
[THIS PAGE INTENTIONALLY LEFT BLANK]

Page | 6 of 6