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Final Exam Chapters 11,12,16,17,18,21,25 Name ______________________ Please do your own work and do not share you work with others - thanks. 1. A bond with a $1,000 par value, 6% coupon (paid annually) and 12 years left to maturity is trading at $827. What is the yield to maturity? 2. For the problem above, if the company's marginal tax rate is 40 percent, what is the after-tax cost of existing debt? 3. Joe Corp's preferred stock has a par value of $100 a share and a market price of $115 a share. Annual dividends are $16.20. What is the cost of existing preferred stock? 4. Bob Corp. is expected to pay a dividend of $12.85 per share over the next year, and the stock is currently selling for $350 a share. If dividends are expected to grow at 2.5 percent a year, what is the cost of existing common stock? 5. S Corporation's common stock has a beta of 1.43. The interest rate on 10 year U.S. Treasury bonds is 2.58 percent. Assuming an average market risk premium of 5.0 percent, use the mean-variance capital asset pricing model to estimate the cost of existing common equity for S Corporation. 6. If a company has a beta of 1.52 and is considering a high risk project outside its normal course or business with a beta of 2.4, what beta should the company use? The 1.52 or the 2.4? Why? 7. A company is operating in three areas of the economy (sectors or industries) and the divisional betas are presented below: Beta Value Division A 2.75 $200,000 Division B .35 $300,000 What is the company's beta? 8. Foe Corporation's has the capital structure given below: Debt (at market value) $2,800,000 Preferred stock (at market value) $600,000 Common stock (at market value) $ 3,200,000 Assuming the market weight are also the target weights for Foe Corp. please calculate the weights that should be used to find the weighted average cost of capital for Foe Corp. 9. For the problem above, if the after tax cost of debt is 4% the cost of preferred stock is 7% and the cost of common stock is 10%, what is the weighted average cost of capital? 10. Martin Corporation is financed with 40% debt and 60% common equity. The after tax cost of debt is 4% and the cost of common equity is 10%. What is Martin's weighted average cost of capital? 11. TNT Corporation is considering the acquisition of BRM Corporation. TNT has 220,000 shares of stock, with earnings per share of $2.50 and a market price per share of $30. BRM has 265,000 shares outstanding with earnings per share of $1.40 and a market price of $10. The merger is expected to increase net income of the combined companies by $275,000 (in synergistic benefits). What is the maximum exchange ratio TNT can offer and what is the minimum exchange ratio BRM could accept? 12. You have been given the job of evaluating the following merger candidate. flow for the acquisition candidate for the proposed merger (in millions): Year 1 2 3 Cash flows now 80 85 105 Additional cash flows with merger 40 90 100 Total cash flows with merger 120 175 205 Risk free rate of return Beta for this project (the company after merging) Market risk premium 3.5% 1.6 5% You have collected the following cash 4 145 125 270 5__ 180 150 330 Pre-tax cost of debt Marginal tax rate Number of shares outstanding for the target company (millions) Current market price per share for the target company Percentage of the acquisition financed with debt Percentage of the acquisition financed with common equity 7.5% 30% 55 $60 50% 50% What is the after tax cost of debt? What is the after tax cost of common equity What is the weighted average cost of capital for this acquisition candidate? What is the maximum price per share you are willing to pay for this candidate? Based on the numbers above, would you pursue this candidate? 13. If oil is found in an exploratory well, there is a .7 probability that the field will prove commercially viable. If the probability of finding oil in an exploratory well is .21, what is the probability that oil will be found in the exploratory well and the field will prove to be commercially viable? 14. If competitors do not respond to a new product, there is a .8 probability of a positive net present value. If competitors do respond, there is a .3 probability of a positive net present value. There is a .7 probability that competitors will respond. What is the probability of a positive net pres-ent value? 15. Possible net present values and associated probabilities for a new investment are as follows. What is the probability of a positive net present value? NPV Probability -150 .10 What is the probability of a positive net present value? What is the expected value? What is the median? What is the mode? 75 .15 60 .15 180 .20 250 .15 320 .25 Final Exam Chapter 11,12,16,17,18,21,25 Name____________________ Please Boldface and Underline the correct response. Thank you and good luck. 1. True - False While there have long been attempts to reduce risk to concrete measures, we are not yet to the point where any one measure adequately describes risk in every situation. 2. True - False Despite the development of more sophisticated approaches, sensitivity analysis and break even analysis continue to be useful tools. 3. True - False The expected value is a commonly used measure of dispersion. 4. True - False The standard deviation is expressed in squared units but the variance is expressed in the same units as the observations. 5. True - False The standard deviation can combine hundreds of possible outcomes in a single risk statistic. 6. True - False The coefficient of variation is calculated by dividing the standard deviation by the expected value. 7. True - False Utility theory is a very useful tool and many corporations are spending many dollars mapping the utility functions of senior level executives and stockholders. 8. True - False Most senior executives are risk averse, meaning they will seek risk only if they expect to be compensated for it. 9. True - False The choice of risk perspective has little influence the choice of the risk measurement statistic. 10. True - False Sensitivity analysis changes multiple variables at one time, while scenario analysis changes just one variable at a time. 11. True - False Income breakeven analysis usually results in a higher breakeven point than NPV breakeven. 12. True - False Expected net present values are calculated by multiplying the possible NPV's by the probabilities and then adding these solutions. 13. True - False Decision trees are gaining in popularity because they identify embedded options and they force managers to do contingency planning. 14. True - False History, expert opinion, and government mandates are three methods for developing probability estimates. 15. True - False Sequential investing is a way to measure risk not a way to manage risk. 16. True - False The weighted average cost of existing capital is the change in the total returns needed to satisfy investors in light of new investment, divided by the amount of capital needed for the investment. 17. True - False The rate paid on the funds raised by the corporation and then used for a new capital investment is the appropriate discount rate for you to use in capital budgeting regardless of the risk of the project. 18. True - False A new investment should not be justified by the benefits of moving to an optimal capital structure. The benefit of moving to an optimal capital structure can be had by raising more of one type of capital and using the proceeds to retire another, without making new investments. 19. True - False Flotation costs are the costs associated with retiring an old issue of debt or equity, such as the fees paid to investment bankers for handling the sale. 20. True - False When calculating the cost of preferred stock, we need not adjust for taxes because dividends do not result in a decrease in the company's income tax. 21. True - False The mean-variance capital asset pricing model approach differs from the constant growth dividend valuation model and the earnings yield model in that it focuses on market returns for investments of similar risk rather than on investor response to a particular security. 22. True - False If markets are perfectly efficient, the market values of debt and equity will equal present values of the expected cash flows for each of these sources of funding. 23. True - False For capital budgeting, we use projected cash flows, not income statement numbers so deferred taxes are a major source of funding and needs to be considered in calculating the weighted average cost of capital. 24. True - False When short-term debt is used as permanent financing and it is clearly part of the company's permanent capital in substance, then it should be treated like other long-term debt in cost of capital analysis. 25. True - False Accounts payable and accrued expenses are a major source of funding that have explicit cost and therefore need to be considered in calculating the weighted average cost of capital . 26. True - False In the absence of market imperfections, the capital structure that maximizes the value of the firm will also be the capital structure that minimized the weighted average cost of capital. 27. True - False In reality (not a perfect market) risk, firm value, and the attractiveness of capital investments will likely be affected by capital structure decisions. 28. True - False The agency cost of equity is highest in an all-debt firm. 29. True - False Spin-off cost is an important deterrent to using too much debt. 30. True - False Capital structure can be part of a system designed to assure that managers maximize their own wealth by acting in the interest of the shareholders. 31. True - False Expected bankruptcy costs decrease as the amount of debt increases. 32. True - False Bankruptcy by itself does not decrease the value of the firm; however, the friction cost associated with bankruptcy does decrease wealth. 33. True - False Information asymmetries are more likely to occur when the company is changing its strategy. 34. True - False If a competitor (more heavily leveraged than your company) experiences a positive response to an increase in leverage, this suggests that additional debt to your capital structure may decrease your share price. 35. True - False An industry leader is more likely to have a more stable earnings pattern and therefore have less debt capacity than other companies in the industry. 36. True - False When comparing your firm to a competitor, it is important to evaluate differences in systematic risk (assuming there are some). 37. True - False Many companies rely on investment bankers to judge the market response because they generally have a good understanding of the bond rating process and continual contact with security analysts. 38. True - False Tax changes combined with transaction cost may cause the market to be in disequalibrium. 39. True - False When conducting a pro-forma analysis, it is necessary to only predict the income statement to calculate the projected financing needs of the organization. 40. True - False The holding of reserves, and the sale of assets are two available resources that may offset negative cash flow. 41. True - False Nonfinancial items should not be considered when determining the optimal financial structure. 42. True - False The lessee uses the assets while the lessor owns the asset. 43. True - False Beta measures diversifiable or nonsystematic risk. 44. True - False The IRS has guidelines for determining if a lease is really an installment sale 45. True - False The ability to shift the risk of obsolescence, serviceability and residual value to the lessee is typical. 46. True - False Leases are often used by companies to remove the cost of assets and the corresponding debt from the balance sheet. 47. True - False Typically, government reimbursement techniques favor ownership over leasing. 48. True - False Vertical integration may involve buying either a customer or a supplier. 49. True - False Horizontal integration involves the purchase of an unrelated business. 50. True - False Information asymmetry could exist where an acquiring firm has a better information set than the market in general. 51. True - False An acquisition is often easier than a proxy battle, but with an acquisition the acquirer must share a greater proportion of the benefits of any value creation. 52. True - False The correlation of compensation with the size of an organization is one reason managers might "do a merger" even if it decreases the wealth of the acquiring companies. 53. True - False Hostile take-over attempts are hostile to the target shareholders but friendly to the target's management. 54. True - False Ignoring taxes -- if you do not believe the synergistic benefits will occur, you should push for a stock for stock merger