FIN 401 Final: FIN401 EXAM.doc

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skydolphin894

4 May 2013

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Abdul owns 200 shares of intec corp. stock. The firm is currently an all equity firm with a market value of ,000,000 and 1,500,000 shares outstanding. Management of the firm is thinking of borrowing 20% of the current value of the firm and buying back shares with the funds. Even if management goes through with the proposed capital structure change, abdul will keep all of his shares. There are no taxes or other market imperfections: how many shares will intec inc. have outstanding after it goes through with its proposed recapitalization? a) b) c) d) Please use the following information to answer the next four questions. Freres inc. has the following market value balance sheet and income. Freres is a non-profit organization and as such does not pay taxes. Raji patel, the owner, is considering borrowing 30% of the current value of the firm and using the funds to buy back equity.

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As CFO of Duke Corp., you are considering a recapitalization plan that would convert Duke Corp. from its current all-equity capital structure to one that includes substantial financial leverage. Duke now has 600,000 shares of common stock outstanding, which are selling for $55 each. You expect the firmâs EBIT to be $3,000,000 for the near future. If there is strong expansion in the economy, then EBIT will be 30 percent higher. If there is a recession, then the EBIT will be 40 percent lower.

The recapitalization proposal is to issue $8,250,000 worth of long-term debt, at an interest rate of 6.0 %, and then to use the proceeds to repurchase 150,000 shares of common stock worth $8,250,000. Assuming there are no market frictions such as corporate or personal income taxes,

(a) Calculate the expected ROE and EPS for Duke Corp under each of the three economic scenarios before any debt issue using the table below

Cash Flows to Stockholders and Bondholders Under Current Capital Structure
	Recession	Normal	Expansion
EBIT
Interest (6.0%)
Net income
Shares outstanding
Earnings per share
Return on equity (P0 = $55.00/sh)

(b) Repeat part (a) assuming that the company goes through with recapitalization using the table

Cash Flows to Stockholders and Bondholders Under Proposed Recapitalization
	Recession	Normal	Expansion
EBIT
Interest (6.0%)
Net income
Shares outstanding
Earnings per share
Return on equity (P0 = $55.00/sh)

oliveelephant279

Please show work if possible!

The residual dividend theory suggests that dividends should be paid to stockholders first and then what is left can be reinvested by the firm.
True.
False.

An investor purchased 300 shares of ABC Inc. stock on Wednesday, December 16. ABC paid its quarterly dividend of $1.10 a share on Thursday, December 31. The record date was Friday, December 18. How much dividend income did the investor receive on December 31 from his investment in JLK stock?
$0.00
$110
$165
$330

The higher the dividend payout ratio, the more a company must rely on external financing.
True
False

Which of the following transactions will increase a corporation's retained earnings?

stock repurchase
stock split
stock dividend
none of the above

JBC Corp. declared a dividend of $2 per share, which was an increase of 25% from the prior year, yet JBC Corp. stock declined by 3% the day of the announcement. RBG Corp. declared a dividend of $2 per share, which was the same as the prior year, and its stock increased in value by 2% on the day of the announcement. These events could be most readily explained by the _________
Information effect.
Residual dividend theory.
Clientele effect.
Expectations theory.

Which one of the following is probably the best argument in favor of a reverse stock split?
to lower the current stock price to its normal trading range
to provide additional shares to all its shareholders
to avoid delisting
to increase the value of the firm

The ex-dividend date is ________ the holder of record date.
2 days before.
5 days before.
2 weeks before.
3 days after.

Edwards Enterprises currently has 145,000 shares of stock outstanding at a market price per share of $57. Today, the firm announced a 3-for-2 stock split. What will the price per share be after the split?
$19.00
$38.00
$47.20
$85.50

Books and More currently has 75,000 shares of stock outstanding, net income of $46,000, and a PE ratio of 18.7. What will the firm's PE ratio be if the firm repurchases 15,000 shares? Assume all else remains constant.
12.67
13.08
14.96
20.23

John owns 1000 shares of stock in Zebar Corporation with a market value of $2,000. Zebar declares a 10% stock dividend. After the dividend is paid, John owns____________

1100 shares with a market value of $2,200.
1000 shares with a market value of $2,200.
1100 shares with a market value of $2,000.
1100 shares with a market value of $2,100.

scarletsea-lion205

Intermediate Financial Management 11th Edition

Chapter 15: Capital Structure Decisions Part 1 Mini Case

Assume you have just been hired as a business manager of PizzaPalace, a regional pizze restaurant chain. The company EBIT was $50 million last year and is not expected to grow. The firm is currently financed with all equity, and it has 10 million shares outstanding. When you took your corporate finance course, your instructor stated that most firms' owners would be financially better off if the firms used some debt. When you suggested this to your new boss, he encouraged you to pursue the idea. As a first step, assume that you obtained from the firm's investment banker the following estimated costs of debt for the firm at different capital structures:

PERCENT FINANCED WITH DEBT, Wd	rd
0%	-
20	8.0%
30	8.5
40	10.0
50	12.0

If the company were to recapitalize, then debt would be issued and the funds received would be used to repurchase stock. PizzaPalace is in the 40% state-plus-federal corprate tax bracket, its beta is 1.0, the risk free rate is 6%, and the market risk premium is 6%.

Please answer All Parts:

Part A: Provide a brief overview of capital structure effects. Be sure to identify the ways in which capital structure can affect the WACC and free cash flows.

Part B: 1) What is business risk? What factors influence a firm's business risk? 2) What is operating leverage, and how does it affect a firm's business risk? Show the operating breakeven point if a company has fixed costs of $200, a sales price of $15, and variable costs of $10.

Part C: Now, to develop an example that can be presented to PizzaPalace's management to illustrate the effects of financial leverage, consider two hypothetical firms: Firm U, which uses no debt financing, and Firm L, which uses $10,000 of 12% debt. Both firms have $20,000 in assets, a 40% tax rate, and an expected EBIT of $3,000. 1) Construct partial income statements, which start with EBIT, for the two firms. 2) Now calculate ROE for both firms. 3) What does this example illustrate about the impact of financial leverage on ROE?

Part D: Explain the difference between financial risk and business risk.

Part E: What happens to ROE for Firms U and L if EBIT falls to $2,000? What does this imply about the impact of leverage on risk and return?

Part F: What does capital structure theory attempt to do? What lessons can be learned from capital structure theory? Be sure to address the MM models.

Part G: What does the empirical evidence say about capital structure theory? What are the implications for managers?

Part H: With the preceding points in mind, now consider the optimal capital structure for PizzaPalace. 1) For each capital structure under consideration, calculate the levered beta, the cost of equity, and the WACC. 2) Now calculate the corporate value for each capital structure.

Part I: Describe the recapitalization process and apply it to PizzaPalace. Calculate the resulting value of the debt that will be issued, the resulting market value of equity, the price per share, the number of shares repurchased, and the remaining shares. Considering only the capital structures under analysis, what is PizzaPalace's optimal capital structure?

graykoala876

FIN 401 Final: FIN401 EXAM.doc

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