Quiz

03 – Part 2A – I5

18 Short Problems x 5 pts each = 90 pts

DURATION: 55 min + 5 min upload
Start: 09:25h
Finish 10:20h
Upload: 10:25h
Instructions:
1. Use clean sheets and write your name on all sheets.
2. Provide clear and legible answers, showing your calculations for the solutions.
3. When you finish, please scan all sheets into a single pdf file using your cell phone
4. Check all pages to make sure that all are clearly legible; if not, substitute the faulty sheets before saving
the file.
5. Save your scan to a pdf file named as: FIRST NAME_LAST NAME_Part 2A
6. Upload the pdf file to the folder Quiz 3 Part 2A in the e-class DropBox
7. Attention: the DropBox will close at 10:25
8. If you experience internet connection problems, send the file by e-mail to ricardo.dellape@fgv.br

Notes:
1. Rounding rules:
o values in percent format (%) must be rounded to 2 decimal places
o ratios, percent or discount factors in decimal format must be rounded to 4 decimal places
o currency values must be rounded to 2 decimal places
2. Grading criteria: Questions will be considered either right or wrong. No partial grades.

Questions:

1. Given are the following data for year 1: Profits after taxes = $14 million;
Depreciation = $6 million; Interest expense = $6 million; Investment in fixed assets
= $12 million; Investment in working capital = $3 million. The corporate tax rate is
25 percent. Calculate the free cash flow (FCF) for year 1.

2. A large firm received a loan guarantee from the government. Due to the guarantee,
the firm can borrow $50 million for five years at 8 percent interest rate per year
instead of 10 percent per year. Calculate the value of the guarantee to the firm.
(Ignore taxes.)

3. A firm has a debt-to-equity ratio of 1. If it had no debt, its cost of equity would be 12
percent. Its cost of debt is 9 percent. What is its cost of equity if there are no taxes?

4. The beta of an all-equity firm is 1.2. Suppose the firm changes its capital
structure to 50 percent debt and 50 percent equity using 8 percent debt
financing. What is the equity beta of the levered firm? The beta of debt is 0.2.
(Assume no taxes)

5. Suppose you borrow at the risk-free rate an amount equal to your initial wealth and
invest in a portfolio with an expected return of 16 percent and a standard deviation
of returns of 20 percent. The risk-free asset has an interest rate of 4 percent.
a. Calculate the expected return on the resulting portfolio.
b. Calculate the standard deviation of the resulting portfolio.
6. A firm's equity beta is 1.2 and its debt is risk free. Given a 0.7 debt to equity
ratio, what is the firm's asset beta? (Assume no taxes)

7. If a firm borrows $50 million for one year at an interest rate of 9 percent, what
is the present value of the interest tax shield? Assume a 30 percent marginal
corporate tax rate.

8. Bombay Company's book and market value balance sheets are as follows:
(NWC=net working capital; LTA = long term assets; D = debt; E = equity; V = firm
value)

According to MM's Proposition I corrected for taxes, what will be the change in
company value if Bombay issues $200 of equity and uses it to make a permanent
reduction in the company's debt? Assume a 35 percent marginal corporate tax rate.

9. Suppose that your firm's current unlevered value, V*, is $800,000, and its
marginal corporate tax rate is 35 percent. Also, you model the firm's PV of
financial distress as a function of its debt level according to the relation: PV of
financial distress = 800,000 × (D/V*)2. What is the firm's levered value if it issues
$200,000 of perpetual debt to buy back stock?

10. Mirion Tech, Inc., has rE of 12 percent, an rD of 6 percent, at a debt-equity ratio of

0.50. Mirion plans to raise enough debt to retire half of their outstanding common
stock, which currently has a market value of $9 million. Calculate Mirion Tech new
WACC after the change in its capital structure. (Assume a 35 percent marginal
corporate tax rate and that rD remains at 6 percent.)

11. Firm A and Firm B are identical except that A is incorporated while B is an
unlimited liability partnership. Both have assets worth $500,000 ($500K) funded
with a debt ratio of 40 percent. Suppose that the assets suddenly become
worthless. What is the maximum possible loss to the equity holders of each
company?

12. The following data on a merger are given:

Firm A has proposed to acquire Firm B at a price of $20 per share for Firm B's stock.
Calculate the gain from the merger.

13. Refer to the previous problem. Firm A has proposed to acquire Firm B at a
price of $20 per share for Firm B's stock. What will be the post-merger
price per share for Firm A's stock if Firm A pays in cash?

14. Analysis of past monthly movements in IBM's stock price produces the following
estimates: α = 2.5 percent and β = 1.6. If the market index subsequently rises by
12 percent in one month and IBM's stock price increases by 20 percent, what is the
abnormal change in IBM's stock price?
 15. Given the following data,

if Firm A offers 250,000 shares to Firm B's shareholders, calculate the cost of the
merger.

16. A firm has a project with an NPV of -$52 million. If it has access to risk-free
government financing that can create a permanent annual tax shield of $5 million,
what is the APV of the project? The opportunity cost of capital is 10% and the
interest rate is 6 percent.

17. Wealth and Health Company is financed entirely by common stock that is priced to
offer a 15 percent expected return. The common stock price is $40/share. The
earnings per share (EPS) is expected to be $6. If the company repurchases 25
percent of the common stock and substitutes an equal value of debt yielding 6
percent, what is the expected value of earnings per share after refinancing? (Ignore
taxes)

18. The historical nominal returns for stock A were -8 percent, +10 percent, and +22
percent. The nominal returns for the market portfolio were +6 percent, +18 percent,
and 24 percent during this same time. Calculate the beta for stock A.