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THE UNIVERSITY OF NEW SOUTH WALES

JUNE / JULY 2006

FINS1613 Business Finance Final Exam

(1)

TIME ALLOWED - 2 hours

(2)

TOTAL NUMBER OF QUESTIONS - 50

(3)

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(4)

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(5)

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(6)

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(7)

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FINS 1613 Final Exam

S1 2006

Multiple Choice - 50 Questions: 1 mark each No negative marking 1) Hiphop Limited must choose between one of two mutually exclusive projects. Project A has an up-front cost (t = 0) of $120,000, and it is expected to produce cash inflows of $80,000 per year at the end of each of the next two years. Two years from now, the project can be repeated at a higher up-front cost of $125,000, but the cash inflows will remain the same. Project B has an up-front cost of $100,000, and it is expected to produce cash inflows of $41,000 per year at the end of each of the next four years. Project B cannot be repeated. Both projects have a cost of capital of 10 percent.

Hiphop wants to select the project that provides the most value over the next four years. What is the net present value (NPV) of the project that creates the most value for the company? a) b) c) d) e) $34,425 $30,283 $29,964 $29,240 $24,537

2)

Which of the following statements is most correct? a) b) c) d) e) Corporations generally face fewer regulations than sole proprietorships do. Corporate shareholders have unlimited liability. It is usually easier to transfer ownership in a corporation than it is to transfer ownership in a sole proprietorship. All of the above statements are correct. None of the above statements is correct.

FINS 1613 Final Exam

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3)

Which of the following statements is most correct? a) b) c) The bird-in-the-hand theory implies that a company can reduce its WACC by reducing its dividend payout. The bird-in-the-hand theory implies that a company can increase its stock price by reducing its dividend payout. One problem with following a residual dividend policy is that it can lead to erratic dividend payouts that may prevent the firm from establishing a reliable clientele of investors who prefer a particular dividend policy. Statements a and c are correct. All of the statements above are correct.

d) e)

You are given the following information about Frugal Fashions. Use this information for the next three questions, numbers 4, 5 and 6. Frugal Fashions is considering opening a new store. In evaluating the proposed project the company's CFO has collected the following information: It will cost $10 million to construct the new store. These costs will be incurred at t=0. These costs will be depreciated on a straight-line basis over the next 10 years. The company will need an additional $5 million of inventory to stock the new store. $2 million of this inventory will be financed with accounts payable, the other $3 million will be paid for in cash. The cost of this net increase in operating working capital will be incurred at t = 0. Assume that this net operating working capital is fully recovered at t = 4. The new store will be open for four years. During each of the four years (t = 1, 2, 3, and 4) the store will produce the following financial projections (in millions of dollars): t=1 $8.0 1.0 7.0 2.8 4.2 t=2 $8.0 1.0 7.0 2.8 4.2 t=3 $8.0 1.0 7.0 2.8 4.2 t=4 $8.0 1.0 7.0 2.8 4.2

EBITDA Depreciation EBIT Taxes Net income

Frugal finances its projects with 100 percent equity; thus, there is no interest expense. The company has a 10 percent weighted average cost of capital. The company assigns a 7 percent cost of capital for its low-risk projects, a 10 percent cost of capital for its average-risk projects, and a 13 percent cost for its above-average risk projects. Frugal estimates that this new store has an average risk. 4) Refer to the information on Frugal Fashions. What are the project's after-tax operating cash flows for each of the four years? a) b) c) d) e) $2.8 million $3.6 million $4.2 million $4.8 million $5.2 million

FINS 1613 Final Exam

S1 2006

5)

Refer to the information on Frugal Fashions. The CFO estimates that the store can be sold after four years for $7.5 million. Frugals tax rate is 40 percent. What is the store's after-tax salvage value at t=4? a) b) c) d) e) $4.5 million $6.0 million $6.6 million $6.9 million $7.5 million

6)

Refer to the information on Frugal Fashions. Assuming the Frugal sells the store after four years for $7.5 million, what is the project's net present value (NPV)? a) b) c) d) e) $ 6.87 million $ 7.49 million $ 7.99 million $10.25 million $10.65 million

FINS 1613 Final Exam

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7)

Martin Corporation currently sells 180,000 units per year at a price of $7.00 per unit; its variable cost is $4.20 per unit; and fixed costs are $400,000. Martin is considering expanding into two additional states, which would increase its fixed costs to $650,000 and would increase its variable unit cost to an average of $4.48 per unit. If Martin expands, it expects to sell 270,000 units at $7.00 per unit. By how much will Martins breakeven sales dollar level change? a) b) c) d) e) $ 183,333 $ 456,500 $ 805,556 $ 910,667 $1,200,000

8)

Partridge Plastic's stock has an estimated beta of 1.4, and its required rate of return is 13 percent. Cleaver Motors' stock has a beta of 0.8, and the risk-free rate is 6 percent. What is the required rate of return on Cleaver Motors' stock? a) b) c) d) e) 7.0% 9.0% 12.0% 11.0% None of these answers

FINS 1613 Final Exam

S1 2006

You are given the following information Fotopoulos Corporation. Use this information for the next three questions, numbers 9, 10 and 11. Currently, the Fotopoulos Corporation's balance sheet is as follows: Assets Total assets $5 billion $5 billion Debt $1 billion Common equity $4 billion Total debt & common equity $5 billion

The book value of the company (both debt and common equity) equals its market value (both debt and common equity). Furthermore, the company has determined the following information: The company estimates that its before-tax cost of debt is 7.5 percent. The company estimates that its levered beta is 1.1. The risk-free rate (k R F ) is 5 percent. The market risk premium (k M k R F ) is 6 percent. The company's tax rate is 40 percent.

In addition, the Fotopoulos Corporation is considering a recapitalization. The proposed plan is to issue $1 billion worth of debt and to use the money to repurchase $1 billion worth of common stock. As a result of this recapitalization, the firm's size will not change. 9) Refer to Fotopoulos Corporation. What is Fotopoulos' current WACC (before the proposed recapitalization)? a) b) c) d) e) 5.92% 9.88% 10.18% 10.78% 11.38%

10)

Refer to Fotopoulos Corporation. What is Fotopoulos' current unlevered beta (before the proposed recapitalization)? a) b) c) d) e) 0.6213 0.8962 0.9565 1.0041 1.2700

FINS 1613 Final Exam

S1 2006

11)

Refer to Fotopoulos Corporation. What will be the company's new cost of common equity if it proceeds with the recapitalization? (Hint: Be sure that the beta you use is carried out to 4 decimal places.) a) b) c) d) e) 10.74% 11.62% 12.27% 12.62% 13.03%

12)

Grant Grocers is considering the following independent, average-risk investment projects: Project Project V Project W Project X Project Y Project Z Size of Project $1.0 million 1.2 million 1.2 million 1.2 million 1.0 million Project IRR 12.0% 11.5% 11.0% 10.5% 10.0%

The company has a target capital structure that consists of 50 percent debt and 50 percent equity. Its after-tax cost of debt is 8 percent, its cost of equity is estimated to be 13.5 percent, and its net income is $2.5 million. If the company follows a residual dividend policy, what will be its payout ratio? a) b) c) d) e) 12% 32% 54% 66% 100%

FINS 1613 Final Exam

S1 2006

13)

Heavy Metal Corp. is a steel manufacturer that finances its operations with 40 percent debt, 10 percent preferred stock, and 50 percent equity. The interest rate on the companys debt is 11 percent. The preferred stock pays an annual dividend of $2 and sells for $20 a share. The companys common stock trades at $30 a share, and its current dividend (D0) of $2 a share is expected to grow at a constant rate of 8 percent per year. The flotation cost of external equity is 15 percent of the dollar amount issued, while the flotation cost on preferred stock is 10 percent. The company estimates that its WACC is 12.30 percent. Assume that the firm will not have enough retained earnings to fund the equity portion of its capital budget. What is the companys tax rate? a) b) c) d) e) 30.33% 32.86% 35.75% 38.12% 40.98%

14)

Flavortech Inc. expects EBIT of $2,000,000 for the coming year. The firms capital structure consists of 40 percent debt and 60 percent equity, and its marginal tax rate is 40 percent. The cost of equity is 14 percent, and the company pays a 10 percent interest rate on its $5,000,000 of long-term debt. One million shares of common stock are outstanding. In its next capital budgeting cycle, the firm expects to fund one large positive NPV project costing $1,200,000, and it will fund this project in accordance with its target capital structure. Assume that new debt will also have an interest rate of 10 percent. If the firm follows a residual dividend policy and has no other projects, what is its expected dividend payout ratio? a) b) c) d) e) 82.6% 60.0% 40.0% 17.4% 5.6%

FINS 1613 Final Exam

S1 2006

You are given the following information about SWK Enterprises. Use this information for the next two questions, numbers 15 and 16 SWK Enterprises has just paid an annual dividend of 40c (D0 = $0.4) out of its current earnings of $2 a share and is forecasted to maintain this payout level for the next 2 years as it thinks that in the next 2 years it can earn an average return on equity of 30%. From year 3 onwards, the dividend will grow at rate 8% due to the competition. Earnings and dividends grow at the same rate. The required return on this stock is 15%. 15) Refer to the information on SWK Enterprises. What is SWKs expected dividend growth rate for the next 2 years? a) b) c) d) e) 6% 8% 15% 24% 64%

16)

Refer to the information on SWK Enterprises. What price would you pay for SWK stock at present? a) b) c) d) e) $ 6.17 $ 6.97 $ 8.07 $ 8.91 $13.93

FINS 1613 Final Exam

S1 2006

17)

You have been given the following information by the CEO: Purchase price of new machine $8,000 Installation charge 2,000 Market value of old machine 2,000 Book value of old machine 1,000 Inventory decrease if new machine is installed 1,000 Accounts payable increase if new machine is installed 500 Tax rate 35% Cost of capital 15%

What is the required cash outflow associated with the acquisition of a new machine; that is, in a project analysis, what is the cash outflow at t = 0? a) b) c) d) e) -$ 8,980 -$ 6,460 -$ 5,200 -$ 6,850 -$12,020

18)

A bond with 6 years to maturity and sells at par has an 8 percent semi-annual coupon (that is, the bond pays a $40 coupon every six months). Another bond of equal risk and maturity pays 8 percent interest annually. Both bonds are non-callable and have face values of $1,000. What is the price of the bond that pays annual interest? a) b) c) d) e) $689.08 $712.05 $980.43 $986.72 $992.64

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19)

Which of the following statements is most correct? a) b) c) d) e) An open-market dividend reinvestment plan is likely to be attractive to companies that are looking to issue additional shares of common stock. Stock repurchases have the effect of reducing financial leverage. If a company does a 2-for-1 stock split, its stock price will roughly double. All of the statements above are correct. None of the statements above is correct.

20)

A money manager is holding a $10 million portfolio that consists of the following five stocks: Stock Amount Invested A $4 million B 2 million C 2 million D 1 million E 1 million Beta 1.2 1.1 1.0 0.7 0.5

The portfolio has a required return of 11 percent, and the market risk premium (k M k R F ) is 5 percent. What is the required return on Stock C? a) b) c) d) e) 7.2% 10.0% 10.9% 11.0% None of these answers

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21)

Which of the following statements is most correct? a) If you were testing dividend theories and found that a dividend increase resulted in higher stock prices, then you could rule out all other theories and conclude that the bird-in-the-hand theory was most consistent with the evidence you found. The clientele effect suggests that investors choose their investments based on firms past dividend policies and changes to established dividend policies may be costly to investors. Dividends paid under a residual dividend policy might send conflicting signals to investors. Statements b and c are correct. All of the statements above are correct.

b)

c) d) e)

22)

Crystal Corporation has a weighted average cost of capital of 11 percent for projects of average risk. Projects of below-average risk have a cost of capital of 9 percent, while projects of above-average risk have a cost of capital equal to 13 percent. Projects A and B are mutually exclusive, whereas all other projects are independent. None of the projects will be repeated. The following table summarizes the cash flows, internal rate of return (IRR), and risk of each of the projects. Project A -$200,000 66,000 66,000 66,000 66,000 12.110% Below Average Project B -$100,000 30,000 30,000 40,000 40,000 14.038% Below Average Project C -$100,000 30,000 30,000 30,000 40,000 10.848% Average Project D -$100,000 30,000 30,000 40,000 50,000 16.636% Above Average Project E -$100,000 40,000 25,000 30,000 35,000 11.630% Above Average

Year 0 1 2 3 4 IRR Project Risk

Which projects will the firm select for investment? a) b) c) d) e) Projects: A, B, C, D, E Projects: A, B, C Projects: B, D, E Projects: B, C Projects: A, D

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23)

Which of the following statements is most correct? a) b) c) d) e) One advantage of dividend reinvestment plans is that they enable investors to avoid paying taxes on the dividends they receive. Stock repurchases make sense if a company is interested in increasing its equity ratio. Stock repurchases make sense if a company believes that its stock is overvalued and that it has a lot of profitable projects to fund over the next year. One advantage of stock repurchases is that they are generally taxed more favorably than dividend payments. One advantage of an open market dividend reinvestment plan is that it increases the number of shares the company has outstanding.

24)

Ripken Iron Works faces the following probability distribution: State of Economy Boom Normal Recession Probability of State Occurring 0.25 0.50 0.25 Stocks Expected Return if this State Occurs 25% 15% 5%

What is the coefficient of variation on the company's stock? a) 0.06 b) 0.47 c) 0.54 d) 0.67 e) None of these answers

25)

If a firm adheres strictly to the residual dividend policy, a sale of new common stock by the company would suggest that a) b) c) d) e) The dividend payout ratio has remained constant. The dividend payout ratio is increasing. No dividends were paid for the year. The dividend payout ratio is decreasing. The dollar amount of investments has decreased.

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26)

Which of the following statements is most correct? a) b) The optimal capital structure minimizes the WACC. If the after-tax cost of equity financing exceeds the after-tax cost of debt financing, firms are always able to reduce their WACC by increasing the amount of debt in their capital structure. Increasing the amount of debt in a firms capital structure is likely to increase the costs of both debt and equity financing. Statements a and c are correct. Statements b and c are correct.

c) d) e)

27)

Which of the following statements is most correct? a) The tax preference theory states that, all else equal, investors prefer stocks that pay low dividends because retained earnings can lead to capital gains that are taxed at a lower rate. An increase in the cost of equity capital (ks) when a company announces an increase in its dividend per share, would be consistent with the bird-in-the-hand theory. An increase in the stock price when a company decreases its dividend is consistent with the signaling theory. A dividend policy that involves paying a consistent percentage of net income is the best policy if the clientele effect is correct. Statements a and d are correct.

b) c) d) e)

28) Stock X and Stock Y sell for the same price in today's market. Stock X has a required return of 12 percent. Stock Y has a required return of 10 percent. Stock X's dividend is expected to grow at a constant rate of 6 percent a year, while Stock Y's dividend is expected to grow at a constant rate of 4 percent. Assume that the market is in equilibrium and expected returns equal required returns. Which of the following statements is most correct? a) b) c) d) e) Stock X has a higher dividend yield than Stock Y. Stock Y has a higher dividend yield than Stock X. One year from now, Stock X's price is expected to be higher than Stock Y's price. Statements a and c are correct. Statements b and c are correct.

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29)

Which of the following statements is most correct? a) The degree of operating leverage (DOL) depends on a companys fixed costs, variable costs, and sales. The DOL formula assumes (1) that fixed costs are constant and (2) that variable costs are a constant proportion of sales. The degree of total leverage (DTL) is equal to the DOL plus the degree of financial leverage (DFL). Arithmetically, financial leverage and operating leverage offset one another so as to keep the degree of total leverage constant. Therefore, the formula shows that the greater the degree of financial leverage, the smaller the degree of operating leverage. The statements above are true. The statements above are false.

b) c)

d) e)

30)

Which of the following statements is most correct? a) b) c) Sinking fund provisions do not require companies to retire their debt; they only establish targets for the company to reduce its debt over time. Sinking fund provisions sometimes work to the detriment of bondholders-particularly if interest rates have declined over time. If interest rates have increased since the time a company issues bonds with a sinking fund provision, the company is more likely to retire the bonds by buying them back in the open market, as opposed to calling them in at the sinking fund call price. Statements a and b are correct. Statements b and c are correct.

d) e)

31) A firm expects its sales to increase by 50 percent in the coming year as a result of recent problems suffered by a competitor. The firm's current EPS is $3.25. Its degree of operating leverage is 1.6, while its degree of financial leverage is 2.1. What is the firm's projected EPS for the coming year using the DTL approach? a) b) c) d) e) $ 3.25 $ 5.46 $10.92 $ 8.71 $19.63

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32)

Clueless Corporation never considers abandonment options or growth options when estimating its optimal capital budget. What impact does this policy have on the companys optimal capital budget? a) b) c) Its estimated capital budget is too small because it fails to consider abandonment and growth options. Its estimated capital budget is too large because it fails to consider abandonment and growth options. Failing to consider abandonment options makes the optimal capital budget too large, but failing to consider growth options makes the optimal capital budget too small, so it is unclear what impact this policy has on the overall capital budget. Failing to consider abandonment options makes the optimal capital budget too small, but failing to consider growth options makes the optimal capital budget too large, so it is unclear what impact this policy has on the overall capital budget. Neither abandonment nor growth options should have an effect on the companys optimal capital budget.

d)

e)

33)

If you know that your firm is facing relatively poor prospects but needs new capital, and you know that investors do not have this information, signaling theory would predict that you would a) b) c) d) e) Issue debt to maintain the returns of equity holders. Issue equity to share the burden of decreased equity returns between old and new shareholders. Be indifferent between issuing debt and equity. Postpone going into capital markets until your firms prospects improve. Convey your inside information to investors using the media to eliminate the information asymmetry.

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34)

Stock A has a beta of 0.8, Stock B has a beta of 1.0, and Stock C has a beta of 1.2. Portfolio P has equal amounts invested in each of the three stocks. Each of the stocks has a standard deviation of 25 percent. The returns of the three stocks are independent of one another (i.e., the correlation coefficients all equal zero). Assume that there is an increase in the market risk premium (k M k R F ), but that the risk-free rate (k R F ) remains unchanged. Which of the following statements is most correct? a) b) The required return of all three stocks will increase by the amount of the increase in the market risk premium. The required return on Stock A will increase by less than the increase in the market risk premium, while the required return on Stock C will increase by more than the increase in the market risk premium. The required return of all stocks will remain unchanged since there was no change in their betas. The required return of the average stock will remain unchanged, but the returns of riskier stocks (such as Stock C) will decrease while the returns of safer stocks (such as Stock A) will increase. The required return of the average stock will remain unchanged, but the returns of riskier stocks (such as Stock C) will increase while the returns of safer stocks (such as Stock A) will decrease.

c) d)

e)

35)

Which of the following statements is correct? a) Business risk is differentiated from financial risk by the fact that financial risk reflects only the use of debt, while business risk reflects both the use of debt and such factors as sales variability, cost variability, and operating leverage. If corporate tax rates were decreased while other things were held constant, and if the Modigliani-Miller tax-adjusted tradeoff theory of capital structure were correct, this would tend to cause corporations to increase their use of debt. If corporate tax rates were decreased while other things were held constant, and if the Modigliani-Miller tax-adjusted tradeoff theory of capital structure were correct, this would tend to cause corporations to decrease their use of debt. The optimal capital structure is the one that simultaneously (1) maximizes the price of the firms stock, (2) minimizes its WACC, and (3) maximizes its EPS. None of the statements above is correct.

b)

c)

d) e)

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36)

Which of the following statements is most correct? a) b) c) d) e) The Tax Code encourages companies to pay large dividends to their shareholders. If your company has established a clientele of investors who prefer large dividends, the company is unlikely to adopt a residual dividend policy. If a firm follows a residual dividend policy, holding all else constant, its dividend payout will tend to rise whenever the firms investment opportunities improve. Statements b and c are correct. All of the statements above are correct.

37)

Hatch Corporations target capital structure is 40 percent debt, 50 percent common stock, and 10 percent preferred stock. Information regarding the company's cost of capital can be summarized as follows:

The pre-tax cost of debt is 7 percent. The company's preferred stock sells for $42 a share and pays an annual dividend of $4 a share. The company's common stock sells for $28 a share, and is expected to pay a dividend of $2 a share at the end of the year (i.e., D1 = $2.00). The dividend is expected to grow at a constant rate of 7 percent a year. The firm will be able to use retained earnings to fund the equity portion of its capital budget. The company's tax rate is 40 percent. What is the companys weighted average cost of capital (WACC)? a) b) c) d) e) 9.25% 9.70% 10.03% 10.59% None of these answers

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38)

Project A has an internal rate of return of 18 percent, while Project B has an internal rate of return of 16 percent. However, if the companys cost of capital (WACC) is 12 percent, Project B has a higher net present value. Which of the following statements is most correct? a) b) c) d) e) The crossover rate for the two projects is less than 12 percent. Assuming the timing of the two projects is the same, Project A is probably of larger scale than Project B. Assuming that the two projects have the same scale, Project A probably has a faster payback than Project B. Statements a and b are correct. Statements b and c are correct.

39)

Which of the following statements is most correct? a) b) c) d) e) Since debt financing raises the firms financial risk, increasing a companys debt ratio will always increase the companys WACC. Since debt financing is cheaper than equity financing, increasing a companys debt ratio will always reduce the companys WACC. Increasing a companys debt ratio will typically reduce the marginal costs of both debt and equity financing; however, it still may raise the companys WACC. Statements a and c are correct. None of the statements above is correct.

40)

Which of the following statements is most correct? a) b) c) d) e) The cost of retained earnings is the rate of return stockholders require on a firm's common stock. The component cost of preferred stock is expressed as k P (1 - T) The higher the firm's flotation cost for new common stock, the more likely the firm is to use preferred stock, which has no flotation cost. All of these answers are correct None of the statements above is correct.

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41)

Makeover Inc. believes that at its current stock price of $16.00 the firm is undervalued in the market. Makeover plans to repurchase 2.4 million of its 20 million shares outstanding. The firms managers expect that they can repurchase the entire 2.4 million shares at the expected equilibrium price after repurchase. The firms current earnings are $44 million. If managements assumptions hold, what is the expected per-share market price after repurchase? a) b) c) d) e) $16.00 $17.26 $18.18 $20.00 $24.40

Dumpty Inc is comparing the operating costs of two types of equipment Model A costs $50,000 and will have a useful life of 4 years. Operating costs are expected to be $4,000 per year. Model B costs $90,000 and will have a useful life of 6 years. Its operating costs are expected to be $2,500 per year. Both models will be able to operate at the same level and quality of output and generate the same cash flows. The applicable discount rate is 8 percent. What annual cost saving will Dumpty achieve if it purchases the cheaper model? a) b) c) d) e) $ 38.31 $ 410.30 $2,872.14 $3,665.34 $6,127.39

42)

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43)

You are an Australian resident taxpayer and you have just received a dividend cheque for $1,400 from Telstra Corporation. The dividend is fully franked and carries franking credits at the corporate rate of tax of 30%. If your personal tax rate is 46 percent in your next tax return you will, as a consequence of this dividend: a) b) c) d) e) Receive a tax refund of $600 Have to pay additional tax of $320 Have to pay additional tax of $224 There are no taxes on fully franked dividends. None of the above.

44)

A consultant has collected the following information regarding Young Publishing: $3,000 million $ 800 million $ 0 million $ 480 million $ 32.00 Tax rate Debt ratio WACC M/B ratio EPS = DPS 40% 0% 10% 1.00 $3.20

Total assets Operating income (EBIT) Interest expense Net income Share price

The company has no growth opportunities (g = 0), so the company pays out all of its earnings as dividends (EPS = DPS). Youngs stock price can be calculated by simply dividing earnings per share by the required return on equity capital, which currently equals the WACC because the company has no debt. The consultant believes that the company would be much better off if it were to change its capital structure to 40 percent debt and 60 percent equity. After meeting with investment bankers, the consultant concludes that the company could issue $1,200 million of debt at a before-tax cost of 7 percent, leaving the company with interest expense of $84 million. The $1,200 million raised from the debt issue would be used to repurchase stock at $32 per share. The repurchase will have no effect on the firms EBIT; however, after the repurchase, the cost of equity will increase to 11 percent. If the firm follows the consultants advice, what will be its estimated stock price after the capital structure change? a) b) c) d) e) $32.00 $33.48 $31.29 $32.59 $34.72

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45)

A company has an EBIT of $4 million, and its degree of total leverage is 2.4. The firms debt consists of $20 million in bonds with a 10 percent yield to maturity. The company is considering a new production process that will require an increase in fixed costs but a decrease in variable costs. If adopted, the new process will result in a degree of operating leverage of 1.4. The president wants to keep the degree of total leverage at 2.4. If EBIT remains at $4 million, what amount of bonds must be outstanding to accomplish this (assuming the yield to maturity remains at 10 percent)? a) b) c) d) e) $16.7 million $18.5 million $19.2 million $19.8 million $20.1 million

You are given the following information Pokeme Instruments. Use this information for the next two questions, numbers 46 and 47. Pokeme Instruments is considering a project that has an up-front cost of $250,000. The project's subsequent cash flows critically depend on whether its products become the industry standard. There is a 50 percent chance that the products will become the industry standard, in which case the projects expected cash flows will be $110,000 at the end of each of the next five years. There is a 50 percent chance that the products will not become the industry standard, in which case the project's expected cash flows will be $25,000 at the end of each of the next five years. Assume that the cost of capital is 12 percent. 46) Refer to the information on Pokeme Instruments. What is the project's expected net present value? a) b) c) d) e) -$ 6,678 $20,004 -$24,701 $45,965 $15,303

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47)

Refer to the information on Pokeme Instruments. Now assume that one year from now Pokeme will know if its products will have become the industry standard. Also assume that after receiving the cash flows at t = 1, the company has the option to abandon the project. If it abandons the project it will receive an additional $100,000 at t = 1, but will no longer receive any cash flows after t = 1. Assume that the abandonment option does not affect the cost of capital. What is the estimated value of the abandonment option? a) b) c) d) e) $ 0 $ 2,075 $ 4,067 $ 8,945 $10,745

48)

An investor has $5,000 invested in a stock that has an estimated beta of 1.2, and another $15,000 invested in the stock of the company for which she works. The risk-free rate (k R F ) is 6 percent and the market risk premium (k M k R F ) is also 6 percent. The investor calculates that the required rate of return on her total ($20,000) portfolio is 15 percent. What is the beta of the company for which she works? a) b) c) d) e) 1.6 1.7 1.8 1.9 None of these answers

FINS 1613 Final Exam

23

S1 2006

49)

What is the future value at the end of year 5 of a 5-year annuity due with annual payments of $200, evaluated at a 15 percent interest rate? a) b) c) d) e) $ 771.01 $ 969.35 $1,348.48 $1,751.04 $1,550.75

50)

A money manager is holding the following portfolio: Stock Amount Invested 1 $300,000 2 300,000 3 500,000 4 500,000 Beta 0.6 1.0 1.4 1.8

The risk-free rate is 6 percent and the portfolios required rate of return is 12.5 percent. The manager would like to sell all of her holdings of Stock 1 and use the proceeds to purchase more shares of Stock 4. What would be the portfolios required rate of return following this change? a) b) c) d) e) 13.63% 10.29% 11.05% 12.52% 14.33%

END
FINS 1613 Final Exam 24 S1 2006