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Final

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FIN 401
RYERSON UNIVERSITY
Final Exam – December 14, 2012 - Solution
Name: __________________________________
Student #:_______________________________
Professor: _______________________________
- Time allowed: 3 hours
- Aids allowed: None, except for an 8’1/2” by 11” double sided cheat sheet and a calculator
- The exam is out of 50 marks, there are 50 MC questions. Each question is worth 1 mark.
- Answer all MC questions on the scan sheet.
- Please put your name, student number, and your professor’s name on the front of this exam.
1. Suppose a 10-year, $1,000 par value bond with an 8% coupon rate and semi-annual coupons is
trading for a price of $1,034.74. What is the bond’s yield to maturity?
a. 3.750%
b. 7.494%
c. 7.500%
d. 7.666%
e. None of the above.
Solution: N = 20, PMT = 40, PV = -1034.74, FV = 1000, compute I = 3.75% YTM = 7.5%
2. You've been offered an investment that will double your money in 10 years. What rate of return are
you being offered?
a. 5.59%
b. 7.18%
c. 20%
d. 100%
e. 200%
Solution: PV = -X, FV = 2X, N = 10, compute I = 7.18%
3. You are considering an investment with the following cash flows. Your required return is 10%, and
you require a payback of three years and a discounted payback of four years. If your objective is to
maximize your wealth, should you take this investment?
Year 0 1 2 3 4 5
Cash Flow -100,000 40,000 40,000 40,000 40,000 -50,000
a. Yes, because the payback is 2.5 years.
b. Yes, because the discounted payback is four years.
16 - 1 c. Yes, because both the payback and the discounted payback are less than two years.
d. No, because the NPV is negative.
e. No, because the project has a large negative cash flow at the end of its life.
4. An investment proposal calls for an initial investment of $12,000. Projected cash inflows over the
next 5 years are $3,000, $4,800, $1,700, $1,700 and $6,000, respectively. If the appropriate discount
rate for the project is 7%, what is the project’s NPV?
a. -$2,319.13
b. $1,958.79
c. $2,359.63
d. $2,595.87
e. None of the above.
CF0 = -12,000 CF1=3000 CF2=4800 CF3=1700 CF4=1700 CF5=6000
I = 7% Compute NPV = $1,958.79
Please use the following information to answer the next FOUR questions.
PV Corp. is trying to decide whether to lease or buy a new high-tech 3D printer system for its printing
business. The system will provide $500,000 in annual pre-tax cost savings. The system costs $6,000,000
and qualifies for a 35% CCA rate. The equipment will have a $200,000 salvage value in 5 years. PV
Corp.'s tax rate is 40% and the firm can borrow at 10%. We Love Leasing Corp. has offered to lease the
3D printer to PV Corp. for payments of $1,500,000 per year. We Love Leasing Corp. requires that its
lessees make payments at the START of the year.
5. What is the present value of the after-tax lease payments?
a. $3,752,879
b. $3,791,127
c. $4,018,595
d. $4,315,154
e. $6,254,798
Solution: N = 5, I = 10% x (1 – 0.4) = 6%, PMT = 1.5M x (1 – 0.4) = 900,000 PV =
$4,018,595
6. What is the NAL of the 3D printer?
a. $88,770
b. -$107,811
c. $41,641
d. -$2,344,014
e. $1,831,953
Solution: NAL = Cost - PV(ATLP) – PV(Salvage) – PV(CCATS)
Cost = 6,000,000
PV(ATLP) = 4,018,595
PV(Salvage) = 200,000/1.06^5 = 149,452
PV(CCATS) = (6m)(0.35)(0.4)/(0.35+0.06) x 1.03/1.06 – (200,000)(0.35)(0.4)/(0.35+0.06) x
1/(1.06)^5 = 1,990,796 – 51,032 = 1,939,764
16 - 2 NAL = 6m – 4018595 – 149452 – 1,939,764 = -107,811
7. What would the minimum before-tax lease payment have to be for PV Corp. to be indifferent between
leasing and buying the 3D printer?
a. $875,854
b. $928,406
c. $1,031,655
d. $1,459,758
e. $1,719,425
Solution: Set NAL = 0 and solve for PV(ATLP)
0 = 6m – PV(ATLP) – 149,452 – 1,939,764
PV(ATLP) = 3,910,784
Set PV = 3,910,784, N = 5, I = 6%, and compute PMT = 875,854
Before-tax lease payment = 875,854/(1 – 0.4) = $1,459,758
8. Now assume that PV Corp. is a firm that does not have to pay any taxes over its lifetime. Which of
the following components of the NAL formula would be affected?
I. The present value of the lease payments
II. The present value of CCATS
III. The present value of the salvage value
IV. The present value of the cost savings
a. II, III, and IV only
b. I, II, and III only
c. I and II only
d. I, II, III, and IV
e. The NAL components would not be affected.
9. Which one of the following statements concerning operating and financial leases is correct?
a. A firm that is restricted from issuing more debt by a bond covenant should enter a financial
lease rather than an operating lease.
b. An operating lease increases the debt-equity ratio of a firm.
c. An operating lease must be reported on the balance sheet of the lessee.
d. A financial lease reduces the net equity in a firm.
e. A financial lease increases the total debt of a firm.
10. On August 29, 2012, the Board of Directors of Acme Company declared a quarterly dividend of
$0.25 per share payable on October 26, 2012 to shareholders of record at the close of business on
October 10, 2012. Assume all days are business days. What is the last day you could buy Acme
Company stock and still get the dividend?
a. October 7 th
th
b. October 8 th
c. October 9 th
d. October 10
e. October 25 th
th th
Solution: Ex-dividend date = Oct. 8 last day to get dividend = Oct. 7
16 - 3 Use the following information to answer the next TWO questions.
PVMT Corp., a long-lived and much-loved brewing company, has decided to cease operations two years
from now. PVMT is an all-equity firm and it will pay a dividend of $5/share next year and a large
liquidating dividend of $30 at the end of the 2nd year. Dividends are at the end of each year. There are
500,000 shares outstanding and the current share price is $28.38. Ignore taxes and assume a discount rate
of 12%.
11. Suppose that an investor in PVMT wanted to smooth out these dividends and would like to generate
equal dividends in each period. How large would each dividend be in this case?
a. $10.00
b. $16.79
c. $17.50
d. $25.00
e. $31.79
Solution: N = 2, I = 12%, PV = -28.38, compute PMT = $16.7924
12. If an investor with 50 shares used homemade dividends to generate these equal dividends, how many
shares would need to be sold at the end of the first year, after the payment of the first dividend?
(Assume fractional shares can be sold.)
a. 11.99 shares
b. 17.60 shares
c. 18.65 shares
d. 27.98 shares
e. None of the above.
Solution: The investor wants equal payments each year of $16.7924 per share (see answer to
previous question), for a total of $839.62 on the 50 shares. The investor receives $250 (50 shares
* $5 dividend) at the end of the first year, leaving a shortfall of $589.62.
P1 = 30/1.12 = $26.7857
$/$26.7857 = 22.01 shares
13. An alternative to a cash dividend payment by the firm from its earnings to the shareholders, achieved
by the firm buying some of its outstanding stock on the open market, is called a:
a. Merger
b. Tender offer
c. Payment-in-kind
d. Stock split
e. Share repurchase
14. The residual dividend approach is based on the premise that:
a. The sale of new equity is a desirable alternative to altering dividend payout.
b. Maintaining a predictable dividend payout is not a primary
objective.
c. Dividends on common stock must be paid first with preferred shareholders getting what's
leftover; that is, the residual.
16 - 4 d. A clientele effect exists.
e. A firm's investment needs are of secondary concern to its dividend policy.
15. Tom & Jones (T&J) has earnings before interest and taxes of $1,549,000. Both the book and the
market value of debt is $3,065,000. The unlevered cost of equity is 15.5% while the pre-tax cost of
debt is 8.5%. The tax rate is 35%. What is the value of the equity in the levered firm?
a. $453,819
b. $915,401
c. $1,650,483
d. $4,503,556
e. $7,214,007
VU = [$1,549,000(1 - .35)] / .155 = $6,495,806
VL = $6,459,806 + (.35 x $3,065,000) = $7,568,556
VE = VL - VD = $7,568,556 - $3,065,000 = $4,503,556
Use the following information to answer the next THREE problems.
The Quilt Shoppe is an all-equity firm that has 5,000 shares of stock outstanding at a market price of $40
a share. Company management has decided to issue $20,000 worth of debt and use the funds to
repurchase shares of the outstanding stock. The interest rate on the debt will be 10%.
16. What is the break-even level of earnings before interest and taxes? Ignore taxes.
a. $21,500
b. $42,833
c. $20,000
d. $5,000
e. None of the above.
Number of shares repurchased = $20,000/$40 = 500
EBIT/5,000 = [EBIT - ($20,000x0.10)]/(5,000 - 500)
EBIT = 100K/5
EBIT = $20,000
17. You own 100 shares of The Quilt Shoppe. If the firm does go through the capital restructuring, and
you prefer the cash flows from the current operation, what should you do?
a. Borrow money at 10% and use the proceeds to buy 10 shares.
b. Sell 10 shares and put the rest in the bank earning 10% interest.
c. Borrow money at 10% and use the proceeds to buy 5 shares.
d. Sell 5 shares and put the rest in the bank earning 10% interest.
e. None of the above.
You will want to achieve a 10/90 d/e ratio, and that will require you to sell 10% of your 100
shares (i.e., 10 shares) and invest the money in a bond.
18. If the firm does NOT go through the capital restructuring, and you prefer the cash flows under the
restructured operation, what should you do? Assume that you own 100 shares.
a. Borrow money at 10% and use the proceeds to buy 11.11 shares.
16 - 5 b. Sell 10 shares and put the rest in the bank earning 10% interest
c. Borrow money at 10% and use the proceeds to buy 5 shares.
d. Sell 5 shares and put the rest in the bank earning 10% interest
e. None of the above.
You will want to create another 10/90 d/e ratio. In this case, your 100 shares are your 90, meaning
that your 10 will be 100/.9 – 100 = 11.11
19. Watson's Feed Mill is an all-equity firm that has 20,000 shares of stock outstanding. The company
has decided to borrow $400,000 to buy out the shares of a family stockholder who holds 1,200 shares.
What is the total value of this firm if you ignore taxes?
a. $5.48 million
b. $6.00 million
c. $6.42 million
d. $6.67 million
e. $7.00 million
Solution: Price per share = 400,000/1200 = 333.333
Value of equity = 333.333 x (20,000 – 1,200) = 6,266,667
Value of firm = value of equity + value of debt = 6,266,667 + 400,000 = $6.67 million
20. Juanita's Steak House has $12,000 of debt outstanding that is selling at par and has a coupon rate of
8%. The tax rate is 34%. What is the present value of the debt tax shield?
a. $2,823
b. $2,887
c. $4,080
d. $4,500
e. $4,633
Solution: Debt tax shield = D * Tc = 12,000 x 0.34 = $4,080
21. The implicit costs associated with corporate default, such as lost sales, are the __________ of the
firm.
a. flotation costs
b. default beta coefficients
c. direct bankruptcy costs
d. indirect bankruptcy costs
e. sunk costs
22. The proposition that a firm borrows up to the point where the marginal benefit of the interest tax
shield derived from increased debt is just equal to the marginal expense of the resulting increase in
financial distress costs is called the:
a. static theory of capital structure.
b. M&M Proposition I.
c. M&M Proposition II.
d. capital asset pricing model.
e. open markets theorem.
16 - 6 23. Assume there are no personal or corporate income taxes and that the firm's WACC is unaffected by
its capital structure. Which of the following is true?
I. A firm's cost of equity depends on the firm's business and financial risks.
II. The value of the firm is dependent on its capital structure.
III. The cost of equity increases as the firm's leverage decreases.
a. I only
b. II only
c. III only
d. I and III only
e. II and III only
24. Shareholders generally prefer that a distressed firm:
a. undergo reorganization under the Bankruptcy and Insolvency Act because the common stock
generally recoups its value.
b. undergo liquidation under the Bankruptcy and Insolvency Act because they have first priority
over the firm's assets.
c. undergo reconstitution under the Bankruptcy and Insolvency Act because that option usually
minimizes shareholder loss.
d. not declare bankruptcy since the common shares are often rendered
worthless.
25. The present value equation is:
a. PV = FV + (t + r) t
b. PV = FV - (t + r) t
c. PV = FV / [1 / (1 + r)] t
t t
d. PV = FV / (1 +tr)
e. PV = FV * (t + r) t
26. A convertible bond has 10 years remaining until maturity, a face value of $1100, and a coupon paid
annually of 6%. If it were a straight bond, it would have a discount rate of 6.5%. It also has a conversion
ratio of 50 and the current share price for the firm’s shares is $20 per share. What is the minimum value
of the bond?
a) $1,000.00
b) $1,060.46
c) $1,092.64
d) $1,100.00
PV of Straight Bond, based on FV = 1100, r = 6.5%, PMT = 66, N = 10, PV = 1060.46
PV of Common Stock = 50 * 20 = $1000
27. Nick buys the option to purchase a used textbook from John in four months for $72. Nick pays a $6
option premium / call price to John now for this option. As it turns out, the textbook is worth $60 in four
months time. What will be Nick’s (not John’s) profit?
a) $-6
b) $-2
16 - 7 c) $0
d) $2
e) None of the a

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