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Advanced Corporate Finance EXIT EXAM | ACCURATE QUESTIONS AND DETAILED ANSWERS, Exams of Finance

Advanced Corporate Finance EXIT EXAM | ACCURATE QUESTIONS AND DETAILED ANSWERS | GUARANTEED PASS | GRADED A | LATEST UPDATE 2024-2025 WITH 200+ QUESTIONS

Typology: Exams

2024/2025

Available from 09/04/2024

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Advanced Corporate Finance EXIT

EXAM | ACCURATE QUESTIONS AND

DETAILED ANSWERS | GUARANTEED

PASS | GRADED A | LATEST UPDATE

2024 - 2025 WITH 200+ QUESTIONS

Suppose that a bond with one year maturity a coupon rate of 5%, and face value of $1000 sells for $881.94. Calculate the promised yield on the bonds.

  • CORRECT ANS-19.06% A corporate bond matures in one year. The bond promises a $50 coupon and a principal payment of $1000 at maturity. If the bi d has a 15% probability of default and payment under default is $400. Calculate the expected payment from the bind
  • CORRECT ANS-$952. A corporate bind matures in one year. The bond promises a coupons of $50 and principal of $1000 at maturity. If the bond has a 10% probability of default and payment under default is $400. Calculate the expected payment for the bond.
  • CORRECT ANS-$ Which of the following are examples of real options?
  • CORRECT ANS-The options to expand if an investment project succeeds, the option to wait (and learn) before investing, the option to shrink or abandon a project, and the option to vary the mix of output or the firms production methods The discounted cash flow (DCF) approach should be
  • CORRECT ANS-Augmented by added analysis if a decision has significant imbedded options

Practical challenges in Applying real options analysis

  • CORRECT ANS-Real options can be complex, the real options problems may not be well structured and competition may reduce or change the value of real options Contrast the difference between the NPV of an investment and the value of the option to invest in it
  • CORRECT ANS-The value of the option to invest increases with interest rates while the NPV decrease and the value of the option to invest decreases with an increase in short term cash flows while NPV increases What might lead a financial manager to decide to expedite a positive net present value investment project?
  • CORRECT ANS-Investment required for the project is expected to increase in the near future If projects have implied options then
  • CORRECT ANS-The shorter the forecasted life of the project, the less valuable the option is The opportunity to defer investing to a later date may have value because
  • CORRECT ANS-Market conditions may change and increase the NPV of the project A project is worth $15 million Today without an abandonment option. SuPpose the value of the project is either $20 million one year for today (if product demand is high) or $10 million (if product demand is low). It is possible to sell off the project for $13 million if product demand is low. Calculate the value of the abandonment option if discount rate of 5% per year.
  • CORRECT ANS-$1.2 million The APV method should be used
  • CORRECT ANS-When the project level of debt is known over the life of the project

The MFC CORPORATION needs to raise $200million for its mega project. The NPV of the project using all equity financing is $40 million. If the cost of raising funds for the project is $20 million, what is the APV of the project?

  • CORRECT ANS-$20 million Flotation costs are incorporated j to the APV framework by
  • CORRECT ANS-Subtracting them from the all equity value of the project The opportunity cost of capital, used to calculate the base-case for adjusted present value analyses can be thought of as
  • CORRECT ANS-The WACC of an all equity financed version of the firm Which of the following is an important assumption required if using the WACC formula? - CORRECT ANS-Companies rebalance the capital structure to mountain a constant debt ratio Lowering the debt-equity ratio of the firm can change the firm's
  • CORRECT ANS-Financial leverage, cost of equity, cost of debt and effective tax rate Given are the following data for outsourcing company PV (of FCCs for years 1-3) = $35 million PV (horizon value) =$65 million. Suppose that the market value of the debt =$30 million. Calculate total market value of equity of the firm.
  • CORRECT ANS-$70 million Give are the following data for year 1; profits after taxes = $20 million, depreciation =$6 million , Interest expense =$4 million, Investment I. Fixed assets = $12 million, Investment in working capital =$4 million. The corporate tax rate is 25%. Calculate the free cash flow(FCF) for 1 year - CORRECT ANS-$13 million When one uses the after tax weighted average cost of capital (WACC) to value a levered firm, the interest tax shield is
  • CORRECT ANS-Automatically considered because the after-tax cost of debt is included within the WACC formula Given are the following data for Golf Corporation Market price/share $12; book value/ share $10; price/bond $800; face value/bond $1000; number of bonds outstanding $1 million. Calculate the proportions of debt (D/V) and equity (E/V) for Golf Corporation that you should use for estimating its weighted average cost of capital (WACC)
  • CORRECT ANS-40% debt and 60% equity To calculate the total value of the firm (v) one should rely on the?
  • CORRECT ANS-Market values of debt and equity When completing a large debt issue, financial managers of large firms will usually consider the following questions
  • CORRECT ANS-Should the firm borrow short term or long term? Should the firm issue fixed or floating rate debt? Should the firm borrow in foreign currency? Generally Managers of corporations prefer internally generated cash to finance their capital expenditure because?
  • CORRECT ANS-They can avoid the discipline of financial markets, the costs of issuing new securities are high and the announcement of a new equity issue is usually bad news for investors Different classes of stocks are usually issued in order to
  • CORRECT ANS-Maintain ownership control by holding the class of stock with greater voting rights The rate event in which a firms existing directors and management compete with outsiders for effective control of the corporation is called?
  • CORRECT ANS-Proxy Contest

If you own 1000 shares of common stock of a firm and there are five directors being elected, what is the maximum number of votes you can cast for A PARTICULAR DIRECTOR UNDER MAJORITY VOTING?

  • CORRECT ANS-1, Which voting system is most friendly towards minority shareholders
    • CORRECT ANS-Cumulative Voting If you own 1,000 shares of stock and you can cast 5,000 votes for a particular director then the stock features
  • CORRECT ANS-Cumulative voting The Marker Value of Equity equals
    • CORRECT ANS-(Market Price)x(number of shares outstanding) A firm has $100 mil in current liabilities, $200 mil in long term debt, $300 mil in stockholders equity and total book assets. of $600 mil. There are 100mil shares outstanding with a share price of $16 calculate the debt ratio for the firm
    • CORRECT ANS-11.1% A Firm has $100 Mil in current liabilities, $200 mil in long term debt,$300 Mil in stockholders equity and total assets of $600 Mil. Calculate the firms ratio of long-term debt to long-term debt plus equity
  • CORRECT ANS-LT Debt/LT Debt +equity =40% Suppose that a bankrupt firm, while in the process of developing a reorganisation plan is allowed to buy goods on credit and borrow money to finance needed working captial. Such an arrangement is called
    • CORRECT ANS-Debtor-in-possession financing

A Conglomerate is a firm that

  • CORRECT ANS-Diversifies across several unrelated businesses Privatisation is?
  • CORRECT ANS-Sale of a government owned company to private investors The simplest way to divest an asset is to?
  • CORRECT ANS-Sell it In Carve-out transactions
  • CORRECT ANS-Shares of the new company are sold in a public offering In a spin off
  • CORRECT ANS-Shares of a new company are given to shareholders of the parent company The largest gainers from Leveraged Buyouts (LBOs) transactions have typically been
  • CORRECT ANS-Selling Stockholders Leveraged buyouts (LBOS) Almost always involve which of the following
  • CORRECT ANS-A large part of the purchase is financed by debt, most of the issued debt is below investment grade (ie Junk) and the firm goes private and its shares are no longer traded on the open market Which methods can be used to modify a company structure
  • CORRECT ANS-Leverage Buyouts, Privatisation, Spin-offs & Carve outs and Bankruptcies Historically merger activity increased with which market condition?
  • CORRECT ANS-High Stock Market prices

Primary market is

  • CORRECT ANS-Purchase of initial issue of shares and bonds Secondary market is
    • CORRECT ANS-Secondary transactions when stock holders sell/trade stock Preferred stock
  • CORRECT ANS-Dividends must be paid before common stock payments Default Risk
  • CORRECT ANS-Likelihood that a firm will walk away from its obligation, either voluntarily or involuntarily Bonds Rating
    • CORRECT ANS-Issued on debt instrument to help investors assess the default risk of a firm Role of financial market and intermediaries
  • CORRECT ANS-Payment mechanisms Borrowing and lending Pooling risk Information Benefits of going public
  • CORRECT ANS-Readily available data on performance Allows management team to be rewarded with stock options Allows to diversify sources of financing

Creating a public offering

  • CORRECT ANS-Management select the underwriters Look at price earning ratios of competitors Dis counters cash flow calcualtions Underwriters receive payment in the form of a spread Underwriters build interest aand sell shares on company behalf what are the 4 way a firm can repurchase stock
  • CORRECT ANS-Firm announces that it plans to buy its stock in the open market Tender offer, firm offers to buy back a stated number of shares at a fixed price. Shareholders can decide whether to accept the offer A Dutch Auction firm states a series of prices at which it is prepared to pre purchase stock. shareholder submit offers. Direct negotiation with major shareholders DRIPs - CORRECT ANS-Automatic Dividend reinvestment plans Ex-dividend
  • CORRECT ANS-If you buy stock on the ex-dividend date, your purchase will not be entered on the company's. Book before the record date to you will not be entitled to a divide Steps to obtain venture funding
  • CORRECT ANS-Prepare a business plan Receive first stage financing Receive subsequent staged financing IPO - CORRECT ANS-INITIAL PUBLIC OFFERING

First offering of stock to the general public Underwriter

  • CORRECT ANS-Firms that buy an issue of securities from a company and results it to the public Eg. Company Incurs $1 Million in expenses Sells Shares at $40 each to underwrite Underwrite sells at $43 Each General Cash Offer - CORRECT ANS-Sales of Securities open to all investors by an already public. Company Spread - CORRECT ANS-Difference between public offer price and price paid by underwriter Seasoned. Offering - CORRECT ANS-Sales of securities by a firm that is already publicly traded Self-Registration - CORRECT ANS-A procedure that allows firms to file one registration statement for several issues of the same security Global Bonds - CORRECT ANS-Bonds where on post is sold. Internationally in the Eurobond market and the remainder sold in the company's domestic market Capital Structure - CORRECT ANS-A Firms mix of debt and equity financing Prospectus - CORRECT ANS-Formal summary that provides information on an issue of securities Underpricing - CORRECT ANS-Issuing securities at an offering price set below that true value of security

Modigliani and Miller (MM) Proposition I - CORRECT ANS-Firms value is determine by real assets,, not securities issues. A Firm cannot change the total value of its securities just by splitting its cash flow into different streams Financial Leverage - CORRECT ANS-El= Vl-Dl Law of Conservation Value - CORRECT ANS-The Value of an asset is preserved regardless of the nature of the claims against it Expected Return on Assets - CORRECT ANS-Ra=Expected operating income/market value of all securities Return on Equity - CORRECT ANS-= Expected return on assets + (expected return on assets- expected return on debt) x debt/equity Weighted Average Cost of Capital (WACC) - CORRECT ANS-WACC= Rd X (1-Tc) x (D/V) + (Re x E/V) Debt Ratio - CORRECT ANS-D/V Equity Ratio - CORRECT ANS-E/V DV (tax Shield) - CORRECT ANS-(Corporate tax rate X interest payment)/(expected return on debt) Value of firm - CORRECT ANS-Value if all-equity financed + PV (tax Shield) Corporate Bankruptcy - CORRECT ANS-Occurs when stockholders exercise their right to default

Legal mechanism allowing creditors to take over when a firm defaults Debt to total capital ratio - CORRECT ANS-D/(d+e) Tax Shield - CORRECT ANS-Depend on the corporate tax rate and on. The ability for the company to earn enough to cover interest payments Values of a firm - CORRECT ANS-Value if all equity financed +PV (tex shield) Fill in the blanks If a lender ranks behind using the firms general creditors in the event of default his or her loan is said to be - CORRECT ANS-Subordinated Fill in the blanks Interest on many banks Loans is based on a __________________ of interest - CORRECT ANS- Floating rate Fill in the blanks A ________________ bond can be exchanged for shreds of the issuing corporation - CORRECT ANS-Convertible A _____________ gives its owner the right to buy shares in the issuing company at a pre determine price - CORRECT ANS-Warrant Dividends on _______________________ cannot be paid unless the firm has also paid any dividends on its ________________ - CORRECT ANS-Common Stock Preferred stock Financed by common stock, $1 Million debt, interest rate 10%, Corporate tax 35%

How much profit is available for common stock holders - CORRECT ANS-Gross Profit interest on $1 mill. Loan =. $760,000-100,000= 600,00-231000 (35%tax)=. 429000 What would decrease the value of a corporate bond? - CORRECT ANS-The Borrower has the option to repay the loan before maturity. THis would reduce the value, because the borrower would probably exercise this option when it. Is beneficial for them to do so. Options that provide a benefit to one party (eg borrower) do so. of the expense of the other party (lender). The bond is subordinated - A bankruptcy, subordinated debt is only paid after the senior debt obligations have been paid in full. The subordinate lender therefore has more risk What would increase the value of a corporate bond? - CORRECT ANS-The Bond is convertible to shares - Increase value. If the share price goes down, the bond holder is under no obligation to convert the bonds to shares, thereby protecting the investment. If the company's share price rises the bond holder can exchange the bond for the more valuable shares The Bond Is secured by a mortgage on real estate - Collateral provides extra protection for the lender Shareholders need to elect 5 Directors - 200000 shares outstanding How many shares do you need to own to ensure that you can elect at least one director - in a company with majority voting - CORRECT ANS-Number of shares = (200,000/(5+1))+

  • 200,000/2+ =100, Shareholders need to elect 5 Directors - 200000 shares outstanding How many shares do you need to own to ensure that you can elect at least one director - in a company with cumulative voting - CORRECT ANS-# of shares needed + (# of shares outstanding/(# open seats +1)) + = (200000/(5+1))+ =

Would you expect voting stock to sell at a higher price than non voting stock - CORRECT ANS- Yes, this is considered to be due to the private benefits captured by the owners of voting shares and potential for additional bargaining power Different classes of stock are usually issues in order to - CORRECT ANS-Maintain ownership control, by holding the class of stock with greater voting rights The Market for venture capital refers to the - CORRECT ANS-A private financial market place for providing equity investments for small start up firms If a shareholder or an on investor wants to acquire a new share of stock under a rights issue they must - CORRECT ANS-Acquire the appropriate number of rights per share and subscription price per share and submit them to the subscription agent Which of the following lists events in chronological order from earliest to latest - CORRECT ANS- Declaration date Ex-dividend date Record date If dividends are paid out an 9 March to stockholders of record. On Friday February 9 - CORRECT ANS-Latest date you could purchases charges Feb 6 What is the likely impact on a typical individual investor if a firm undertakes. a stock repurchase in lieu of a cash dividend? - CORRECT ANS-Lower income taxes, if capital gains tax rates are. Less than dividend tax rates According to survey data, which is the least often cited dividend policy consideration? - CORRECT ANS-Firms would prefer to raise new funds rather than reduce dividends New Word Corporation 1,000,000 shares $30/share

$13.5 Mil of $27/share - CORRECT ANS-$1/right Generally true of venture Capital (VC) firms? - CORRECT ANS-Vis generally provide management advice and contacts in additional to capital Miller and Modigliani's indifference proposition regarding dividend policy - CORRECT ANS- Assume that investors can sell their stock at a fair price One possible reason that shareholders often insist on higher dividends is - CORRECT ANS-They do not trust managers to spend retained earnings wisely If. Dividends are taxed more heavily than capital gains than investors - CORRECT ANS-Should be willing to pay more. For stocks with low dividend yields A firm in Australia earns a pretax profit of $A10 per share. Suppose that it pays a corporate tax of $3 per share (30% tax rate) in taxes. The firm pays the remaining $A7 in dividends to a shareholders in the 330% marginal tax bracket What is the amount of additional tax paid by the shareholders under an imputation tax system?

  • CORRECT ANS-$ An investor can undo the effect of leverage on his/her own account by - CORRECT ANS- Investing in the equity of an unreversed firm and investing in risk-free debt like T-bills Modigliani and Miller's Proposition I states that - CORRECT ANS-The Market value of any firm is independent of its capital structure Modigliani and Millers Proposition II states that - CORRECT ANS-The expected return on equity is positively related to leverage, the required return on equity is a linear function of the firm's debt to equity ratio and the risk to equity increases with leverages For a levered firm - CORRECT ANS-EBIT increased

EPS increased by a larger percentage The effect of financial leverage on the performance of the firm depended on the - CORRECT ANS-Firm's level of operating income A policy of Maximizing the value of the firm is the same as a policy of minimising. The weighted average cast of capital providing that - CORRECT ANS-The firm's investment policy is settles there are no taxes and an issue of new debt does not affect the market value of existing debt Learn and earn company is financed entirely by common stock that is priced to offer a 20% expected return. If the company repurchases 50% of the stock and substitutes an equal value of debt yield 8%, what is the expected return on its common stock after refinancing? - CORRECT ANS-32% A firm has a debt to equity ratio of 1. IF it had no debt , it's cost of equity would be 12%. It's cost of debt is 9%. What is it's cost of equity if there are no taxes? - CORRECT ANS-15% Assume. The following data for U & P company: Debt = $100 million Equity =$300 million Rd=6% Re=12% Tc=30% Calculate the after-tax weighted average cost of captial (wacc). - CORRECT ANS-V=(E+D) WACC=((E/V). X Re)+[((D/V)X Rd) X (1-t)] WACC=((300/400) X .12+[((100/400) X .6) X (1-.30)] WACC = 10.05%

Here are book and market value balance sheets of the United Frypan Company (UF). Assume MM's theory holds with taxes. There is growth and the $40 of debt is expected to be permanant. Assume a 40% corporate rate. Book Networking capital 20 I40 Debt Long term assets 80 I60 Equity Total 160 Market Networking capital 20 I40 Debt Long term assets 140 I120 Equity Total 160 How much of the firms value is accounted for by the debt generated tax shield? - CORRECT ANS-PV tax shield = TcD =.40 X $ = $ Here are book and market value balance sheets of the United Frypan Company (UF). Assume MM's theory holds with taxes. There is growth and the $40 of debt is expected to be permanant. Assume a 40% corporate rate. Book Networking capital 20 I40 Debt Long term assets 80 I60 Equity Total 160 Market Networking capital 20 I40 Debt Long term assets 140 I120 Equity

Total 160 How much better off will UFs shareholders be if. The firm borrows $20 more and uses it to repurchase stock - CORRECT ANS-Increase in Equity = Tc X increase in debt =.40 X $ = $ What is the relative tax advantage of corporate debt if the corporate tax rate is Tc=.35. The personal tax rate is Tp=.35 but all equity income is received as capital gains and escapes tax entirely (Tpe=0)? How does the relative tax advantage change if the company decided to pay out all equity income a cash dividends that are taxed at 15% - CORRECT ANS-Capital Gains Relative advantage of debt = .65/(1x.65) = Cash Dividends Relative advantage of debt = .65/(.85 X.65) =1. On February 29, 2009 when PDQ computers announced bankruptcy, it's share price fell from $ to $0.5 per share. There were $10 million. shares outstanding. Does this imply bankruptcy costs of 10x (3-.5) =$25 mil? Explain - CORRECT ANS-Not necessarily. Announcement of bankruptcy can send a message of poor profits and prospects. Part of the share price drop can be attributed to anticipated bankruptcy costs, however. Why does asymmetric information punch companies to raise external funds by borrowing rather than issuing common stock? - CORRECT ANS-When a company issues securities , outside investors worry that management may have unfavourable information. If so the securities can be overpriced. This worry is much less with debt than equity. Debt securities are safer than equity, and their price is less affected if unfavourable news comes out later.

A company that can borrow (without incurring substantial costs of financial distress) usually does so. An issue of equity would be read a "bad news"by investors, and the new stock could be sold on;y at a discount to the previous market price. Compute the present value of interest tax shields generated by these 3 debt issues. Consider corporate taxes only. The marginal tex rate is Tc=. A $1000 one year loan at 8% - CORRECT ANS-PV tax shield = Tc(rdD)/(1+Rd) =[.35(.08 X $1000)]/(1+.08) = $25. Compute the present value of interest tax shields generated by these 3 debt issues. Consider corporate taxes only. The marginal tex rate is Tc=. A 5 year loan of $1000 at 8%. Assume no principal repaid - CORRECT ANS-PV tax. Shield ={ [.35(.08 X. $1000)]/(1 +.08)t =$111. Compute the present value of interest tax shields generated by these 3 debt issues. Consider corporate taxes only. The marginal tex rate is Tc=. A $1000 perpetuity at 7% - CORRECT ANS-PV tax shield = TcD =.35 X $ = $ The salad oil storage (SOS) company has financed a large part of its facilities with long-term debt. There is a significant risk of default but the company is not on the ropes yet. Explain Why SOS stockholders could lose by investing in a positive NPV project financed by an equity issue. - CORRECT ANS-SOS stockholders could lose if they invest in the positive NPV project and then SOS becomes bankrupt. Under these conditions, the benefits of the project accrue to the bondholders The salad oil storage (SOS) company has financed a large part of its facilities with long-term debt. There is a significant risk of default but the company is not on the ropes yet. Explain

Why SOS stockholders could gain by investing in a negative NPV project financed by cash - CORRECT ANS-If the new project is sufficiently risky, then even though it has a negative NPV, it might increase stockholders wealth by more than the money invested. This is a result of the fact that, for a very risky investment, undertaken by a firm with a significant risk of default, stockholders benefit if a more favourable outcome is actually realised, while the cost of unfavourable outcomes is borne by bondholders The salad oil storage (SOS) company has financed a large part of its facilities with long-term debt. There is a significant risk of default but the company is not on the ropes yet. Explain Why SOS stockholders could gain from paying out large cash dividends - CORRECT ANS-Suppose SOS pays out lump-sum dividend. Stockholders get all of the assets, and the bondholders are left with nothing. Some corporations debt-equity targets are expressed not as a debt ratio but as a target deb rating on the firm's outstanding Bonds. What are the Pro's and Con's of setting a target rating rather than a targeting ratio. - CORRECT ANS-One advantage of setting debt-equity targets based on bond ratings is that firms may minimise borrowr=ing costs. This is especially true of bond covenants that establish lower ratings as a condition of default. One disadvantage is that firms may not take full advantage of tax benefits from debt financing if they refuse to borrow amounts they could finance with relative safety. Most financial Managers measure debt ratios from their companies book balance sheets. Many financial economists emphasise ratios from market value balance sheets. Which is the right measure in principle? - CORRECT ANS-The right measure in principle is the ratio derived from market-value balance sheets. Book balance sheets represent historical values for debt and equity, which can be significantly different from market values. Any changes in capital structure are made at current market values Most financial Managers measure debt ratios from their companies book balance sheets. Many financial economists emphasise ratios from market value balance sheets Does the trade off theory propose to explain book or market leverage? - CORRECT ANS-The trade off theory proposes to explain market leverage. Increase or decreases in debt levels take place at market values. For example a decisions to reduce the likelihood of financial distress by

retirement of debt means that existing debt is acquired at market value and that the resulting decrease in interest tax shields is based on the market value of the retired debt. Similarly , a decision to increase tax shields by increasing debt requires that new debt be issued at current market prices Most financial Managers measure debt ratios from their companies book balance sheets. Many financial economists emphasise ratios from market value balance sheets How about the pecking order theory? - CORRECT ANS-Similarly, the pecking order theory is based on market values of debt and equity. Internal financing from reinvested earnings is equity financing based on current market values; the alternate to increased internal financing is a distribution of earnings to shareholders. Debt capacity is measured by the current market value of debt because the financial markets view the amount of existing debt as the payment required to pay off that debt What are some of the possible consequences of financial distress? - CORRECT ANS-Equity investors would like the firm to shift toward riskier lines of business One indirect costs to bankruptcy is the incentive toward under investment. Following this strategy may result in - CORRECT ANS-Stockholders may turn down low risk, low return even with Positive NPV projects The firm declaring and paying high cash dividends Inclusion of restrictions in a bond contract leads to - CORRECT ANS-Lower Agency Costs Common mistakes with WACC - CORRECT ANS-Tempts people to make logical errors Only for projects that are a carbon copy of the firm Immediate source of funding for a Project has no necessary connection with the hurdle You cannot increase debt ratio without creating financial risk and increasing rE A project costs $1million and has a base-case NPV of exactly zero (NPV 0). What is the project's APV in the following cases?

a. If the firm invests, it has to raise $500,000 by a stock issue. Issue costs are 15% of net proceeds. - CORRECT ANS-APV = base-case NPV+/- PV financing side effects APV= 0-.15($500,000) APV=-$75,000 A project costs $1million and has a base-case NPV of exactly zero (NPV 0). What is the project's APV in the following cases? If the firm invests, its debt capacity increases by $500,000. The present value of interest tax shields on this debt is $76,000. - CORRECT ANS-APV = base-case NPV+/- PV financing side effects APV=0 +$76,000 APV- $76,000 Whispering Pines, Inc., is all-equity-financed. The expected rate of return on the com- pany's shares is 12%. a. Whatistheopportunitycostofcapitalforanaverage-riskWhisperingPinesinvestment? - CORRECT ANS-12%; For an all-equity-financed company, the opportunity cost of capital is expected rate of return on the company's Shares. Whispering Pines, Inc., is all-equity-financed. The expected rate of return on the com- pany's shares is 12%. b. Suppose the company issues debt, repurchases shares, and moves to a 30% debt-to- value ratio (D/V .30). What will the company's weighted-average cost of capital be at the new capital structure? The borrowing rate is 7.5% and the tax rate is 35%. - CORRECT ANS-Re = .12 + (.12 - .075)(30/70) Re=.1393, pr 13.93% WACC = .075(1-.35)(.30) + .1393(.70) WACC=.1121 or 11.21%

Consider a project to produce solar water heaters. It requires a $10 million investment and offers a level after-tax cash flow of $1.75 million per year for 10 years. The opportunity cost of capital is 12%, which reflects the project's business risk. a. Suppose the project is financed with $5 million of debt and $5 million of equity. The interest rate is 8% and the marginal tax rate is 35%. The debt will be paid off in equal annual installments over the project's 10-year life. Calculate APV. - CORRECT ANS-Base-case NPV =- $10m+ $1.75({1-[1/(1+.12)10]}/.12) Base-case NPV =-$122,110 APV=base-case NPV + PV(tax shield) PV(tax shield) is computed from the following table APV=-$112,110+575,736 APV=$463,626 Consider a project to produce solar water heaters. It requires a $10 million investment and offers a level after-tax cash flow of $1.75 million per year for 10 years. The opportunity cost of capital is 12%, which reflects the project's business risk. b. HowdoesAPVchangeifthefirmincursissuecostsof$400,000toraisethe$5million of required equity? - CORRECT ANS-APV=base-case NPV + PV(tax shield) - equity issue costs APV+-$112,110+575,736-400,000 APV=$63,626 The Bunsen Chemical Company is currently at its target debt ratio of 40%. It is contem- plating a $1 million expansion of its existing business. This expansion is expected to pro- duce a cash inflow of $130,000 a year in perpetuity. The company is uncertain whether to undertake this expansion and how to finance it. The two options are a $1 million issue of common stock or a $1 million issue of 20-year debt. The flotation costs of a stock issue would be around 5% of the amount raised, and the flotation costs of a debt issue would be around 11⁄2%.

Bunsen's financial manager, Ms. Polly Ethylene, estimates that the required return on the company's equity is 14%, but she argues that the flotation costs increase the cost of new equity to 19%. On this basis, the project does not appear viable. On the other hand, she points out that the company can raise new debt on a 7% yield, which would make the cost of new debt 81⁄2%. Sh - CORRECT ANS-Note the following: The cost of debt and equity are not 8.5% and 19%, respectively. These figures assume the issues costs are paid every year, not just a issue. The fact that Bunsen can finance the entire cost of the project with debt is irrelevant. The cost of capital does not depend on the immediate source of funds; what matters is the project's contribution to the firm's overall borrowing power. The Project is expected to support debt in perpetuity. The fact that the first debt issue is for only 20 years is relevant. Assume the project has the same business risk as the firm's other assets. Because it is a perpetuity, we can use the firm's weighted-average cost of capital. If we ignore issue costs: WACC=[Rd X (1-Tc) X (d/V)] + {Re X (E/V)] WACC == [0.07 X. (1-.35) X .4. +[[.14 X.6]] WACC=.1022, or. 10.22% Using this. Discount. Rate: NPV=-$1,000,000+$130,,000/..1022 NPV=$272,916 The issue. Costs. are: Stock issue cost=.050x$1,000,000 Stock issue cost. =$50,000

Bond issue cost=..015x$1,000,000 Bond. Issue cost =$15,000 Debt is clearly less expensive.. Ignoring. Future issue costs implications and basing current. Issue. Costs. On debt, the NPV is;; NPV net of issue costs = $272,016-15,000 NPV. Net. Of issue costs = $257,016 However, if debt is used, the firm's debt ratio will be above the target ratio, and more equity will have to be raised later. If equity financing can be obtained using retained earnings, then there are no other Issue Costs to Consider. If stock will be issued to regain the target debt ratio an additional issue cost is. Incurred. A careful estimate of the issue costs attributable to this project would require a comparison of Bunsen's financial plan with as compared to without this project Nevada Hydro us 40% debt-financed and has a weighted-average cost of capital of 9.7%: WACC+(1-Tc)Rd D/V +Re E/V =(1-.35)(.085)(.40)+.125(.50)=.97 Goldensacks Company is advising Nevada Hydro to issue $75 million of preferred stock at a dividend yield of 9%. The proceeds would be used to re purchase and retire common stock. The preferred issue would account for 10% of the pre issue market value of the firm.

Goldensaks argues that these transactions would redact Nevada Hydro's WACC to 9.4% WACC=(1-.35)(.85)(.40)+.09.10)+.125(.50) =.094 or 9.4% Do you agree with this calculation? explain - CORRECT ANS-Disagree. The Goldensacks calculations are based on the assumption that the costs of debt will remain constant and that the costs of equity capital will not change even though the firm;s financial structure has changes. The former assumption is appropriate while the latter is not A start-up company is moving into its first offices and needs desks, chairs, filing cabinets and other furniture. It can buy the furniture for $25,000 or rent it for $1,500 per month. The founders are of course confident n their new venture, but nevertheless they rent. Why? What's the option? - CORRECT ANS-The option is the abandonment value of the used furniture. the company can buy furniture and resell (Abandon) if these start-up fails, but the abandonment value of used furniture is not great. If's often better to retain flexibility by renting You own a parcel of vacant land. you can develop it now or wait. What is the advantage of waiting? - CORRECT ANS-You learn more about land prices and best use of the land You own a parcel of vacant land. you can develop it now or wait. Why might you decided to develop the property immediately? - CORRECT ANS-By developing immediately, you capture rents immediately Gas turbine are among the lease efficient ways to product electricity, mush less thermally efficient than coal or nuclear plants. Why do gas-tubone generating stations exit? What's the option? - CORRECT ANS-Gas turbines can be started up on short notice when spark spreads are