Final Exam

ADM 3350
Corporate Finance
Summer, July 29th, 2020
Professor: Dr. Dev Gandhi Time: 3 hours
Maximum Marks: 50 2:00 p.m. – 5:00 p.m.
NAME:
STUDENT #:

Formulas: Refer to the course binder, which has all the formulas we covered.
PLEASE NOTE: Show all relevant calculations to support your answers. Also
remember that you are ethically bound to do the exam entirely on your own. There
should be no evidence to the contrary.
GOOD LUCK!

POINTS ALLOCATION
Part I
• Problem 1: 10 points
• Problem 2: 4 points
• Problem 3: 4 points
• Problem 4: 6 points
Part II
• MCQ: 26 points

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 PART I: (24 point)
PROBLEM 1 (10 points; 6 points for part a, 4 points for part b)

Suppose you work as a strategic financial manager at Nadia Inc., a large

telecommunications firm which is considering making an offer to purchase Shaan Inc. a
smaller network company. You have collected the following information for this important
financial decision:
Nadia Shaan
Price-earnings ratio 8 6
Shares outstanding 500,000 220,000
Earnings $1,500,000 $440,000
Securities analysts expect the earnings and dividends (currently $1 per share) of Shaan to
grow at a constant rate of 4% each year. Nadia management believes that its acquisition of
Shaan will generate some economies of scale increasing Shaan’s dividend per share growth
rate to 6% per year. Based on this belief, Nadia is considering the following two alternative
ways of acquiring Shaan:
Alternative 1
Acquire Shaan by paying $15 cash per share for Shaan’s stock.
Alternative 2
Acquire Shaan by share exchange ratio of l:4 (i.e. one share of Nadia for 4 shares of Shaan).
Required
a. Which of the above two alternatives Should Nadia choose? Support your answer
with calculations.
b. At what exchange ratio of Nadia's shares to Shaan's shares would the shareholders
of Shaan be indifferent between Nadia's cash or stock offer for their stock? Show
calculations to support your answer.

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 PROBLEM 2 (4 points; 2 points for each part)

A firm maintains a capital structure with debt-equity ratio of 2/3 and has $24,000 earnings
for the year-end. The firm follows a residual dividend policy.
a. What is the maximum capital budget amount the firm can finance without raising
external equity?
b. Suppose the firm's capital structure before financing the maximum capital
budget consisted of $500,000 debt and $750,000 equity. Calculate the firm's debt
ratio after financing the maximum capital budget in part (a).

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 PROBLEM 3 (4points)
Consider equally risky, all-equity financed firms G and D. Both firms are currently trading
at $50 per share. Firm G pays no dividends, but firm D pays all its earnings as dividends.
In a year from today, the stock of firm G is expected to be at $65 per share. Firm D is
expected to pay a $15 dividend per share at the year-end and its stock price at the year-end
is expected to be $50 per share. Capital gains are taxed at half the 40% regular income tax
rate, but the dividend income is taxed at 30%.

Required

At what share price should the stock of firm D be trading to-day in a competitive stock
market? Show calculations to support your answer.

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 PROBLEM 4 (6 points; 3 points for each part)

A manufacturer offers a $30,000 computer network system under either a financial lease
or an operating lease. The system is expected to have a useful life of 6 years and no residual
value. The system is eligible for 30% CCA rate on the declining balance. Your firm wants
to acquire the system; its tax rate is 40% and the before-tax interest rate on a 6-year term
loan is 15%.
a. What are the maximum annual year-end lease payments the manufacturer could
demand for your firm to prefer a 6-year financial lease over purchase of the system?
Show calculations.
b. Suppose the alternative of operating lease requires annual lease payments of
$10,000. In what situation with respect to the useful life of the system the operating
lease would be a better alternative for your firm? Show calculations.

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