QUESTION 1 Similar to the example in class when I discussed Is it bankruptcy or bankruptcy costs, the following table shows asset, debt, and equity time 1 cash flows (first two columns of numbers), expected time 1 cash flows (third column of numbers), and present values (last column of numbers) for a firm The amount of money loaned to the firm is $60 and it has a 50 chance of bankruptcy (i e , in the bad state), but bankruptcy costs $0 Bad state (50 ) Good state (50 ) Expected PV Assets $50 $170 $110 $110 1 1 $100 Debt $50 $76 $63 $63 1 05 $60 Equity $0 $94 $47 $47 1 175 $40 Now assume that bankruptcy costs $23 (Of course, you will only have to pay the bankruptcy costs in the bad state ) Including bankruptcy costs in the analysis, what promised interested rate will you need to pay the lender so that the lender still makes an expected return of 5 on the $60 loan to the firm Enter your answer as a percent to two decimal places (e g , 0 1250 12 50 ) If the answer is negative, enter with the minus sign (e g , enter as 12 50 ) Full credit within 0 02 of the correct answer (e g, 12 48 12 52 ) Partial credit within 0 10 of the correct answer (e g, 12 40 12 60 ) QUESTION 2 Assume a company pays a $1 35 dividend per share The stocks price is $26 47 per share on the day before the stocks ex dividend day and $26 6 on the ex dividend date What is the stocks return for this one day period Enter your answer as a percent to two decimal places (e g , 0 1250 12 50 ) If the answer is negative, enter with the minus sign (e g , enter as 12 50 ) Full credit within 0 02 of the correct answer (e g , 12 48 12 52 ) Partial credit within 0 10 of the correct answer (e g , 12 40 12 60 ) QUESTION 3 You are an unlevered firm and are trying to decide whether to issue debt (and therefore become a levered firm) Assume the corporate income tax rate is 30 (i e , Tc 30 ) In addition, the personal tax rate on debt income is 40 (Tp 40 ) and the personal tax rate on equity income is 20 (Tpe 20 ) Taking into account both corporate and personal taxes, and using the method discussed in class, is there a tax advantage or tax disadvantage for this unlevered firm to issuing debt and becoming a levered firm There is a tax advantage to issuing debt (i e , the combined corporate and personal tax will be less for the levered firm) There is a tax advantage to remaining unlevered (i e , the combined corporate and personal tax will be less for the unlevered firm) QUESTION 4 Assume markets are perfect as described in Chapter 17 Firm U and Firm L have the exact same assets (managed in exactly the same way) Firm U has no debt The market value of Firm Us equity is $7500 Firm L has risk free perpetual debt with a market value of $3000 and equity with a market value of $5000 Therefore, the market values of Firm U and Firm L are $7500 and $8000 respectively Since these two firms do not have the same market value, you should be able to earn a true arbitrage What are the three positions you need to take at time zero to earn a true arbitrage profit (Use the procedures we discussed in class Also, as in class, assume alpha 10 You must get all three answers correct to get credit ) Pick one A Sell short $300 of Firm L equity B Sell short $500 of Firm L equity C Sell short $750 of Firm U equity Enter the letter (A, B, or C) for the correct answer in the box here Pick one D Invest $500 into the debt of Firm L E Invest $300 into the debt of Firm L F Borrow $300 Enter the letter (D, E, or F) for the correct answer in the box here Pick one G Invest $800 into the equity of Firm U H Invest $750 into the equity of Firm U I Invest $400 into the equity of Firm L J Invest $500 into the equity of Firm L Enter the letter (G, H, I, or J) for the correct answer in the box here QUESTION 5 Assume markets are perfect and in equilibrium as described in Chapter 17 Using the following values and the CAPM equation, what is A (i e , the beta for the following firms assets) Notes perfect market equations In equilibrium, required returns (based on risk) expected returns CAPM equation E(r A ) r f A (E(r M ) rf) WACC D V E(r D ) E V E(r E ) E(r E ) E(r A ) (E(r A ) E(r D )) D E (MM Proposition 2 equation) A D V D E V E E A ( A D ) D E r E E(r E ) E 1 5 r f 2 r D E(r D ) 8 D r M E(r M ) 12 r A E(r A ) A Solve for this D V 0 2 Enter your answer to two decimal places (e g , 12 50) If the answer is negative, enter with the minus sign (e g , enter as 12 50) Full credit within 0 01 of the correct answer (e g, 12 49 12 51) Partial credit within 0 05 of the correct answer (e g, 12 45 12 55) Note there are two versions of this question This question asks for the beta of the assets, A The other version asks for the expected return of the assets, E(r A ) Repeat the quiz until you get to see both versions

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QUESTION 1 Similar to the example in class when I discussed Is it bankruptcy or bankruptcy costs, the following table shows asset, debt, and equity

QUESTION 1

Similar to the example in class when I discussed Is it bankruptcy or bankruptcy costs, the following table shows asset, debt, and equity time 1 cash flows (first two columns of numbers), expected time 1 cash flows (third column of numbers), and present values (last column of numbers) for a firm. The amount of money loaned to the firm is $60 and it has a 50% chance of bankruptcy (i.e., in the bad state), but bankruptcy costs = $0.

	Bad state (50%)	Good state (50%)	Expected	PV
Assets	$50	$170	$110	$110/1.1 = $100
Debt	$50	$76	$63	$63 / 1.05 = $60
Equity	$0	$94	$47	$47 / 1.175 = $40

Now assume that bankruptcy costs = $23. (Of course, you will only have to pay the bankruptcy costs in the bad state.) Including bankruptcy costs in the analysis, what promised interested rate will you need to pay the lender so that the lender still makes an expected return of 5% on the $60 loan to the firm?

Enter your answer as a percent to two decimal places (e.g., 0.1250 = 12.50%). If the answer is negative, enter with the minus sign (e.g., enter as -12.50%). Full credit: within 0.02% of the correct answer (e.g, 12.48% - 12.52%). Partial credit: within 0.10% of the correct answer (e.g, 12.40% - 12.60%).

QUESTION 2

Assume a company pays a $1.35 dividend per share. The stocks price is $26.47 per share on the day before the stocks ex-dividend day and $26.6 on the ex-dividend date. What is the stocks return for this one-day period?

Enter your answer as a percent to two decimal places (e.g., 0.1250 = 12.50%). If the answer is negative, enter with the minus sign (e.g., enter as -12.50%). Full credit: within 0.02% of the correct answer (e.g., 12.48% - 12.52%). Partial credit: within 0.10% of the correct answer (e.g., 12.40% - 12.60%).

QUESTION 3

You are an unlevered firm and are trying to decide whether to issue debt (and therefore become a levered firm). Assume the corporate income tax rate is 30% (i.e., Tc = 30%). In addition, the personal tax rate on debt income is 40% (Tp = 40%) and the personal tax rate on equity income is 20% (Tpe = 20%). Taking into account both corporate and personal taxes, and using the method discussed in class, is there a tax advantage or tax disadvantage for this unlevered firm to issuing debt and becoming a levered firm?

		There is a tax advantage to issuing debt (i.e., the combined corporate and personal tax will be less for the levered firm).
		There is a tax advantage to remaining unlevered (i.e., the combined corporate and personal tax will be less for the unlevered firm).

QUESTION 4

Assume markets are perfect as described in Chapter 17. Firm U and Firm L have the exact same assets (managed in exactly the same way). Firm U has no debt. The market value of Firm Us equity is $7500. Firm L has risk-free perpetual debt with a market value of $3000 and equity with a market value of $5000. Therefore, the market values of Firm U and Firm L are $7500 and $8000 respectively. Since these two firms do not have the same market value, you should be able to earn a true arbitrage. What are the three positions you need to take at time zero to earn a true arbitrage profit? (Use the procedures we discussed in class. Also, as in class, assume alpha = 10%. You must get all three answers correct to get credit.)

Pick one

A. Sell short $300 of Firm L equity

B. Sell short $500 of Firm L equity

C. Sell short $750 of Firm U equity

Enter the letter (A, B, or C) for the correct answer in the box here:

Pick one

D. Invest $500 into the debt of Firm L

E. Invest $300 into the debt of Firm L

F. Borrow $300

Enter the letter (D, E, or F) for the correct answer in the box here:

Pick one

G. Invest $800 into the equity of Firm U

H. Invest $750 into the equity of Firm U

I. Invest $400 into the equity of Firm L

J. Invest $500 into the equity of Firm L

Enter the letter (G, H, I, or J) for the correct answer in the box here:

QUESTION 5

Assume markets are perfect and in equilibrium as described in Chapter 17. Using the following values and the CAPM equation, what is _A (i.e., the beta for the following firms assets)?

Notes & perfect market equations:

In equilibrium, required returns (based on risk) = expected returns

CAPM equation: E(r_A) = r_f + _A (E(r_M) rf)

WACC = D/V E(r_D) + E/V E(r_E)

E(r_E) = E(r_A) + (E(r_A) - E(r_D)) D/E (MM Proposition 2 equation)

_A = D/V _D + E/V _E

_E = _A + (_A - _D) D/E

r_E= E(r_E) =

_E = 1.5

r_f = 2%

r_D = E(r_D) = 8%

_D =

r_M = E(r_M) = 12%

r_A= E(r_A) =

_A = Solve for this

D/V = 0.2

Enter your answer to two decimal places (e.g., 12.50). If the answer is negative, enter with the minus sign (e.g., enter as -12.50). Full credit: within 0.01 of the correct answer (e.g, 12.49 - 12.51). Partial credit: within 0.05 of the correct answer (e.g, 12.45 - 12.55).

Note - there are two versions of this question. This question asks for the beta of the assets, _A. The other version asks for the expected return of the assets, E(r_A). Repeat the quiz until you get to see both versions.