1. Firm XYZ has the following financial information: A ROE of 10%, a payout ratio of 40%, the earnings to be paid by the end of this term is $5.00, the required return is 15%. A peer competitor in the same industry, firm ABC’s CFO now is considering acquiring XYZ at a price of 25$ per share. While the CEO of ABC takes it as a ridiculous suggestion. Which side do you take? Why? (Assuming the market is efficient enough) (5 points)

2. (CAPM) A negative-beta stock implies that it offers even lower expected return than risk-free rate. Hence a rational investor would never pick the stock since he/she gets no pay for bearing risk (5 points).

3. (Capital structure)AA Tours is comparing two capital structures to determine how to best finance its operations. The first option consists of all equity financing. The second option is based on a debt-equity ratio of 0.45. What should AA Tours do if its expected sales are less than the accounting break-even level? Describe your choice and explain why. (5 points)

4. (Agency cost) What are the effect of leverage on firm value in case of financial distress? Give several examples to illustrate how the agency risk affect firm value in financial distress. (5 points)