Finance class 425

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Part I: True or false. 1. Cook Inc. is a $2 billion firm with equal amounts of debt and equity. If it decides to issue another $.5 billion in debt, its cost of equity will rise. 2. Cook Inc. is a $2 billion firm with equal amounts of debt and equity. If it decides to issue another $.5 billion in debt, its cost of debt will rise. 3. Cook Inc. is a $2 billion firm with equal amounts of debt and equity. If it decides to issue another $.5 billion in debt, its WACC will rise. 4. In December 2013, Hilton, the world's biggest hotel operator, raised $2.35 billion in a record initial public offering for a lodging company. We would expect this IPO to have worse long-term abnormal performance than the average IPO. 5. In December 2013, Hilton, the world's biggest hotel operator, raised $2.35 billion in a record initial public offering for a lodging company. We would expect this IPO to have a lower initial day return than the average IPO. 6. The WACC is most accurately calculated using the book values of debt and equity. 7. The legal costs of a single firm's bankruptcy can exceed $2 billion. 8. Dometic Group, a Swedish maker of appliances for boats and recreational vehicles, recently had a $1.7 billion IPO. This IPO was backed by a venture capital firm. 9. A firm's levered cannot be smaller than its unlevered . 10.The Altman Z score is used to estimate the value of a firm. 11.IPOs backed by venture capital or private equity firms have better long-term performance than the average IPO. 1 12.A relatively high aggregate volume of new equity issues versus new debt issues is a good signal for future equity market performance. 13.The fact that a cancer research firm has a negative EVA ( ROIC - WACC) is a poor signal for the firm's equity investors. 14.Suppose you have a fixed rate mortgage on your Pebble Beach mansion at a rate of 6%. It would make sense to refinance this mortgage if mortgage interest rates rise. 15.Suppose a firm has a WACC = .09 and a tax rate of .2. It is considering an issue of preferred stock with a dividend of $4.5 and a price of $50. The next annual dividend will be paid in exactly one year. After the issue the firm's WACC would be unchanged. Part II: Numerical answers 16.Suppose Aulet Inc. today has issued a 10-year bond with a yield of 8% and a 4% coupon paid annually. The bond has a par value of $1,000. What is the price of this bond? 17.Suppose Aulet Inc. today has issued a 10-year bond with a yield of 8% and a 4% coupon paid annually beginning in exactly 7 years. The bond has a par value of $1,000. What is the price of this bond? 18.Suppose Aulet Inc. today has issued a 10-year bond with a yield of 8% and a 4% coupon paid annually. The bond has a par value of $1,000. It is currently callable by the issuer at its par value. It is convertible into 20 shares of Aulet, which currently have a price of $40. What is the approximate price of this bond? 2 3 Suppose you currently have a mortgage with 13 years remaining with annual payments (the next one to be paid in exactly one year). The original mortgage was a 30-year loan for $1 million at a rate of 6% (the first payment made at the end of the first year). 19.What is your current annual payment? 20.What is your current mortgage balance outstanding? 21.Assume you are considering refinancing this mortgage with a new 13-year mortgage with annual payments at the current rate of 4%. What is the present value of refinancing assuming you make all the remaining payments? 22.Suppose Bickel Tandoori Ovens Inc. currently has no debt: its = 1.3; the riskfree rate is .01; the expected equity risk premium is 6%; Bickel Tandoori Ovens Inc.'s tax rate = .2. What is its WACC? 23.Bickel Tandoori Ovens Inc. currently has 4 million shares outstanding with a price per share of $15. Suppose Bickel Tandoori Ovens has decided to issue $30 million in debt (without changing the amount of equity outstanding). What is its new 24.If Bickel Tandoori Ovens new debt is a 7-year zero coupon bond with a par value of $1000 and a price of $853, would this debt be investment grade? 25.After the new issue of debt, what is Bickel Tandoori Ovens' WACC? 4 26.Suppose the expected excess return on the S&P500 (flatter line) for 2016 was 10%. Based on the above figure, what can you say about the expected excess return on this firm? 5 Consider the above value profile for 2 projects. 27. Based on the graph, what is the IRR of Project B? 28. If your firm had no debt and a =1.5, which project (if any) would you accept (why)? 29. Which project has its cash flows further in the future than the other project? Why? 30. At what interest rates is Project A better than Project B? 6 7