FIN 516 Final Exam

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FIN 516 Final Exam

Question 1. (TCO B) Which of the following statements concerning the MM extension with growth is not correct?

Question 2.(TCO D) Which of the following statements is most correct?

Question 3. (TCO E) Buster's Beverages is negotiating a lease on a new piece of equipment that would cost $100,000 if purchased. The equipment falls into the MACRS 3-year class, and it would be used for 3 years and then sold, because the firm plans to move to a new facility at that time. The estimated value of the equipment after 3 years is $30,000. If the borrow and purchase option is used, the cash flows would be the following: (Year 1) -2,400; (Year 2) -3,800; (Year 3) -1,400; (Year 4) -79,600; all of these cash outflows would be at the beginning of the respective years. Alternatively, the firm could lease the equipment for 3 years, with annual lease payments of $29,000 per year, payable at the beginning of each year. The firm is in the 20% tax bracket. If it borrows and purchases, it could obtain a 3-year simple interest loan, to purchase the equipment at a before-tax interest rate of 10%. If there is a positive net advantage to leasing, the firm will lease the equipment. Otherwise, it will buy it. What is the NAL?

Question 4. (TCO I) Suppose hockey skates sell in Canada for 105 Canadian dollars, and 1 Canadian dollar equals 0.71 U.S. dollars. If purchasing power parity (PPP) holds, what is the price of hockey skates in the United States?

Question 5. (TCO C) Dentaltech Inc. projects the following data for the coming year. If the firm follows the residual dividend policy and also maintains its target capital structure, what will its payout ratio be?

Question 6. (TCO F) Warren Corporation's stock sells for $42 per share. The company wants to sell some 20-year, annual interest, $1,000 par value bonds. Each bond would have 75 warrants attached to it, each exercisable into one share of stock at an exercise price of $47. The firm's straight bonds yield 10%. Each warrant is expected to have a market value of $2.00 given that the stock sells for $42. What coupon interest rate must the company set on the bonds in order to sell the bonds-with-warrants at par?

Question 7. (TCO B) Reynolds Resorts is currently 100% equity financed. The CFO is considering a recapitalization plan under which the firm would issue long-term debt with a yield of 9% and use the proceeds to repurchase common stock. The recapitalization would not change the company's total assets, nor would it affect the firm's basic earning power, which is currently 15%. The CFO believes that this recapitalization would reduce the WACC and increase stock price. Which of the following would also be likely to occur if the company goes ahead with the recapitalization plan?

Question 8. (TCO G) Which of the following statements is most correct?
(a) Our bankruptcy laws were enacted in the 1800s, revised in the 1930s, and have remained unaltered since that time.
(b) Federal bankruptcy law deals only with corporate bankruptcies. Municipal and personal bankruptcy are governed solely by state laws.
(c) All bankruptcy petitions are filed by creditors seeking to protect their claims against firms in financial distress. Thus, all bankruptcy petitions are involuntary as viewed from the perspective of the firm's management.

Question 9. (TCO I) In 1985, a given Japanese imported automobile sold for 1,476,000 yen, or $8,200. If the car still sold for the same amount of yen today but the current exchange rate is 144 yen per dollar, what would the car be selling for today in U.S. dollars?

Question 10. (TCO H) Which of the following statements is most correct?

Question 11. (TCO A) An investor who writes standard call options against stock held in his or her portfolio is said to be selling what type of options?

Question 12. (TCO F) A swap is a method used to reduce financial risk. Which of the following statements about swaps, if any, is not correct?

FIN 516 Week 1 Homework

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FIN 516 Week 1 Homework

Problem 17-7 on Ex-dividend Price Based on Chapter 17 Payout Policy

Natsam Corporation has $250 million of excess cash. The firm has no debt and 500 million shares outstanding with a current market price of $15 per share. Natsam’s board has decided to pay out this cash as a one-time dividend.

Problem 17-15 on Distribution to Shareholders Based on Chapter 17 Payout Policy

Suppose that all capital gains are taxed at a 25% rate and that the dividend tax rate is 50%.

Arbuckle Corporation is currently trading for $30 and is about to pay a $6 special dividend.

Problem 17-19 on Dividend Capture Strategy Based on Chapter 17 Payout Policy

Que Corporation pays a regular dividend of $1 per share. Typically, the stock price drops by $0.80 per share when the stock goes ex-dividend. Suppose the capital gains tax rate is 20%, but investors pay different tax rates on dividends.

Absent transactions costs, what is the highest dividend tax rate of an investor who could gain from trading to capture the dividend?

Problem 23-5 on Preferred Stock Based on Chapter 23 Raising Equity Capital

Three years ago, you founded your own company. You invested $100,000 of your money and received 5 million shares of Series A preferred stock. Since then, your company has been through three additional rounds of financing.

FIN 516 Week 2 Homework

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FIN 516 Week 2 Homework

Problem 14-11 Based on Chapter 14: WACC and Modigiani & Miller Extension Models With Growth Assumptions

Consider the entrepreneur described in Section 14.1 (and referenced in Tables 14.1–14.3). Suppose she funds the project by borrowing $750 rather than $500.

a. According to MM Proposition I, what is the value of the equity? What are its cash flows if the economy is strong? What are its cash flows if the economy is weak?

b. What is the return of the equity in each case? What is its expected return?

c. What is the risk premium of equity in each case? What is the sensitivity of the levered equity return to systematic risk? How does its sensitivity compare to that of unlevered equity? How does its risk premium compare to that of unlevered equity?

d. What is the debt-equity ratio of the firm in this case?

e. What is the firm’s WACC in this case?

Problem 14-18 Based on Chapter 14: WACC and Modigliani & Miller Extension Models With Growth Assumptions

In mid-2012, AOL Inc. had $100 million in debt, total equity capitalization of $3.1 billion, and an equity beta of 0.90 (as reported on Yahoo! Finance). Included in AOL’s assets was $1.5 billion in cash and risk-free securities. Assume that the risk-free rate of interest is 3% and the market risk premium is 4%.

a. What is AOL’s enterprise value?

b. What is the beta of AOL’s business assets?

c. What is AOL’s WACC?

Problem 15-15 Based on Chapter 15: Debt and Taxes

Acme Storage has a market capitalization of $100 million and debt outstanding of $40 million. Acme plans to maintain this same debt-equity ratio in the future. The firm pays an interest rate of 7.5% on its debt and has a corporate tax rate of 35%.

a. If Acme’s free cash flow is expected to be $7 million next year and is expected to grow at a rate of 3% per year, what is Acme’s WACC?

b. What is the value of Acme’s interest tax shield?

FIN 516 Week 2 Minicase (Microsoft Corporation)

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FIN 516 Week 2 Minicase

Select a major industrial or commercial company based in the United States and listed on one of the major stock exchanges in the United States. Each student should select a different company. Avoid selecting an insurance company or a bank, because the financial ratios for these financial businesses are different. Write a seven-to-eight-page, double-spaced paper answering and demonstrating with calculations and financial data the following questions.

FIN 516 Week 3 Homework

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FIN 516 Week 3 Homework

Problem 20-6 on Call Options Based on Chapter 20

(Excel file included)

You own a call option on Intuit stock with a strike price of $40. The option will expire in exactly 3 months’ time.

a) If the stock is trading at $55 in 3 months, what will be the payoff of the call?

b) If the stock is trading at $35 in 3 months, what will be the payoff of the call?

c) Draw a payoff diagram showing the value of the call at expiration as a function of the stock price at expiration.  

Problem 20-8 on Put Options Based on Chapter 20

(Excel file included)

You own a put option on Ford stock with a strike price of $10. The option will expire in exactly 6 months’ time.

a) If the stock is trading at $8 in 6 months, what will be the payoff of the put?

b) If the stock is trading at $23 in 6 months, what will be the payoff of the put?

c) Draw a payoff diagram showing the value of the put at expiration as a function of the stock price at expiration.

Problem 20-11 on Return on Options Based on Chapter 20

Consider the September 2012 IBM call and put options in Problem 20-3. Ignoring any interest you might earn over the remaining few days’ life of the options, consider the following.

a) Compute the break-even IBM stock price for each option (i.e., the stock price at which your total profit from buying and then exercising the option would be 0).

b) Which call option is most likely to have a return of −100%?

c) If IBM’s stock price is $216 on the expiration day, which option will have the highest return?

Problem 21-12 on Option Valuation Using the Black Scholes Model Based on Chapter 21

Rebecca is interested in purchasing a European call on a hot new stock—Up, Inc. The call has a strike price of $100 and expires in 90 days. The current price of Up stock is $120, and the stock has a standard deviation of 40% per year. The risk-free interest rate is 6.18% per year.

a) Using the Black-Scholes formula, compute the price of the call.

b) Use put-call parity to compute the price of the put with the same strike and expiration date.

Problem 30-14 on Swaps Based on Chapter 30

Your firm needs to raise $100 million in funds. You can borrow short-term at a spread of 1% over LIBOR. Alternatively, you can issue 10-year, fixed-rate bonds at a spread of 2.50% over 10-year treasuries, which currently yield 7.60%. Current 10-year interest rate swaps are quoted at LIBOR versus the 8% fixed rate.

Management believes that the firm is currently underrated and that its credit rating is likely to improve in the next year or two. Nevertheless, the managers are not comfortable with the interest rate risk associated with using short-term debt.

Problem 30-6 on Futures Contract Based on Chapter 30

(Excel file included)

Your utility company will need to buy 100,000 barrels of oil in 10 days, and it is worried about fuel costs. Suppose you go long 100 oil futures contracts, each for 1,000 barrels of oil, at the current futures price of $60 per barrel. Suppose futures prices change each day as follows.

FIN 516 Week 3 Homework ES

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FIN 516 Week 3 Homework ES

1. (TCO B) In which of the following situations may taxpayers file as married filing jointly? (Becker CPA Review Course)

2. (TCO F) A business bad debt is deductible for tax purposes as a(n):

3. (TCO I) Which of the following is subject to the Uniform Capitalization Rules of Code Sec. 263A? (Becker CPA Review Course)

4. (TCO A) Which of the following does not constitute tax evasion?

5. (TCO C) Which of the following items is not subject to federal income tax?

6. (TCO B) Sam owes Bob $8,000. Bob cancels (forgives) the debt. The cancellation is not a gift, and Sam is neither insolvent nor bankrupt. Which of the following statements is correct concerning the impact of this transaction?

7. (TCO I) David, a cash basis taxpayer, owns two rental properties. Based on the following information, compute the amount that he must include in his 2012 gross rental income.

Property #1, security deposit on one-year lease received 2/1/12
All of deposit returned at lease end: $1,000
Property #1, payment received 2/1/12 for last month of lease(1/13): $900
Property #1, rental income received in 2012 2/12-12/12: $8,000
Property #2, rental income received in 2012 1/12-12/12: $9,600
Property #2, security deposit received 1/1/12 to be used for last month's rent: $800
Property #2, rent 1/13 received 12/28/12: $800

8. (TCO F) Section 197's intangible assets, such as patents and trademarks, are amortized for tax purposes over:

9. (TCO E) Explain the assignment of income doctrine (AID) and the fruit of the tree doctrine. What role does the AID play in our federal income tax system, and what could be done to avoid or reduce income taxes if the AID did not exist?

10. (TCO G) Answer the following questions concerning tax laws.

a. What roles do the U.S. Constitution and U.S. Congress play in creating the tax law?
b. What does the common body of tax law (CBOTL) consist of? Briefly explain how a tax bill becomes a tax law.
c. What role does the Internal Revenue Service play in interpreting, and providing guidance on, the tax law? What types of tax law guidance are published by the IRS?

FIN 516 Week 4 Homework

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FIN 516 Week 4 Homework

Problem 23-3 on Implied Price of Funding Based on Chapter 23

Starware Software was founded last year to develop software for gaming applications. Initially, the founder invested $800,000 and received 8 million shares of stock. Starware now needs to raise a second round of capital, and it has identified an interested venture capitalist. This venture capitalist will invest $1 million and wants to own 20% of the company after the investment is completed.

a) How many shares must the venture capitalist receive to end up with 20% of the company? What is the implied price per share of this funding round?

b) What will the value of the whole firm be after this investment (the post-money valuation)?

Problem 23-4 on IRR of Venture Capital Based on Chapter 23

(Excel file included)

Suppose venture capital firm GSB partners raised $100 million of committed capital. Each year over the 10-year life of the fund, 2% of this committed capital will be used to pay GSB’s management fee.

As is typical in the venture capital industry, GSB will only invest $80 million (committed capital less lifetime management fees). At the end of 10 years, the investments made by the fund are worth $400 million. GSB also charges 20% carried interest on the profits of the fund (net of management fees).

a) Assuming the $80 million in invested capital is invested immediately and all proceeds were received at the end of 10 years, what is the IRR of the investments GSB partners made? That is, compute IRR ignoring all management fees.

b) Of course, as an investor or limited partner, you are more interested in your own IRR (that is, the IRR including all fees paid). Assuming that investors gave GSB partners the full $100 million up front, what is the IRR for GSB’s limited partners (that is, the IRR net of all fees paid)?

Problem 23-13 on IPO Based on Chapter 23

Your firm has 10 million shares outstanding, and you are about to issue 5 million new shares in an IPO. The IPO price has been set at $20 per share, and the underwriting spread is 7%. The IPO is a big success with investors, and the share price rises to $50 on the first day of trading.

a) How much did your firm raise from the IPO?

b) What is the market value of the firm after the IPO?

c) Assume that the post-IPO value of your firm is its fair market value. Suppose your firm could have issued shares directly to investors at their fair market values in a perfect market with no underwriting spread and no underpricing. What would the share price have been in this case, if you raise the same amount as in part a)?

d) Comparing part b) and part c), what is the total cost to the firm’s original investors due to market imperfections from the IPO?