Corporate Finance, Fall 03 Exam #2 review questions (full solutions at end of document)


 Barnaby Hutchinson
 3 years ago
 Views:
Transcription
1 Corporate Finance, Fall 03 Exam #2 review questions (full solutions at end of document) 1. Portfolio risk & return. Idaho Slopes (IS) and Dakota Steppes (DS) are both seasonal businesses. IS is a downhill skiing facility, while DS is a tour company that specializes in walking tours and camping. The returns on each company over the next year is expected to be: Economy Idaho Slopes Dakota Steppes Strong Downturn 10% 2% Mild Downturn 4% 7% Slow Growth 4% 6% Moderate Growth 12% 4% Strong Growth 20% 4% a) Find the mean and variance of returns for each company. b) Find the covariance and correlation of returns for the two companies. c) If IS and DS are combined in a portfolio with 50% invested in each, find the portfolio expected return and standard deviation. IS = 4.4 DS = 4.6 s 2 IS = s 2 DS = s DS = r IS,DS = r p = 4.5 s P = ) CAPM Kindercare Inc. has a beta of The risk free rate is 6% and the expected return on the market portfolio is 14.5%. The company presently pays an annual dividend of $5 per share, and investors expect it to experience a growth in dividends of 1% per annum for many years to come. a. What is the stock s present market price per share, assuming the required rate of return is determined by the CAPM? b. Consider an alternative investment in the stock of Maxicare Inc. Maxicare has an expected return of 15% and a beta of 1.5. Should you purchase this stock? (why or why not?) a. P = b. dont buy Maxicare. 3) CAPM The riskfree rate is 5.5%, and the market portfolio has an expected return of 14%. The market portfolio has a standard deviation of 10%. Stock Z has a correlation coefficient with the market of 0.2 and a standard deviation of 12%. According to the CAPM, what is the expected rate of return on stock Z? r z = 7.54% 4. Cost of capital
2 Hook Corp. has $100 million face value of outstanding debt with a coupon of 10% and a yield to maturity of 8% (annualized). The bonds make semiannual payments, and have 10 years to maturity. The company also has 1 million shares of common stock with book value per share of $35 and a market value per share of $50. The current beta of the stock is 1.5. The treasury Bill rate is 5%, and the market risk premium is 8.5%. The company is in the 40% tax bracket. What is the company s current weighted average cost of capital? r WACC = 8.76% 5. Risk & Return: Estimating beta. You wish to estimate the beta of your company by looking at comparable firms. You have gathered the data on the firms indicated below. If you are currently allequity financed and face a tax rate of 35%, what would be an appropriate estimate for your beta? Firm Beta D/E X Y Z b unlev = Cost of capital a. Einstein Bagels is considering expanding into the gourmet coffee business. The coffee business is expected to be 20% of the overall firm value in 1998, and the average beta of comparable coffee firms is 1.30; the average debt/equity ratio for these firms is 60%. The marginal corporate tax rate is 36%. Einstein's equity beta at the end of 1997 was 0.90, and the company's debt/equity ratio was 80%. If Einstein maintains its current debt equity ratio, what will its equity beta be in 1998? b. After the expansion, Einstein's cost of debt will be 11%. If the Treasury bond rate is 7%, and the historical market risk premium is 5.5%, find Einstein's weighted average cost of capital. a. New Einstein levered beta = 1 b. WACC = 10.07% 7. Capital Structure: Modigliani Miller Theorems Assume you are in a Modigliani Miller world with corporate taxes but no costs of financial distress. GTE has perpetual EBIT of $8 million per year and an all equity discount rate (r 0 ) of 12%. GTE has $15 million of debt outstanding at a cost 8%, and its corporate tax rate is 34%. a) What is GTE s value? b) What is GTE s cost of equity? a. V L = $49.1 b. R S = 13.16%
3 8. Capital Structure Theory a. Assume you are in a Modigliani Miller world (MM propositions I and II hold). AB Corporation is unlevered and is valued at $640,000. AB is currently deciding whether including debt in their capital structure would increase their value. Under consideration is issuing $300,000 in new debt with an 8% interest rate. AB would repurchase $300,000 of stock with the proceeds of the debt issue. There are currently 32,000 shares outstanding and their effective marginal tax bracket is zero. (i) What will the firm value be after the change? (ii) What will the share price be and how many shares will be outstanding after the change? b. Now assume you are in a Modigliani Miller world with corporate taxes added. CD Corp. is all equity financed with 5,000 shares outstanding worth $7 each. They are planning on issuing $10,000 of new perpetual debt at the 8% market rate of interest. The effective tax rate is 25%. What is the market value of the firm s outstanding equity after they make the debt for equity exchange? a.i. New firm value: $640,000 (MM Prop I) a. ii. Number of shares outstanding = 17,000, Share price = $20/share b. E = 27, Capital Structure. You have been asked by AB Corporation to evaluate its capital structure. The company currently has 20 million shares outstanding trading at $20 per share. In addition, it has $250 million public debt outstanding, rated AA and with a yield to maturity of 8%. The beta for the company is 1.0, the current Treasury bond rate is 6%, and the market risk premium is 5.5%. The tax rate is 40%. AB Corporation is proposing to borrow an additional $150 million to use as follows:  Repurchase $30 million worth of stock  Pay $80 million in dividends  Invest $40 million in a project with a NPV of $30 million. The additional borrowing will cause the bond rating to fall to BBB, which currently carries a yield to maturity of 10%. How will the firm s cost of capital change with this additional borrowing? (hint: to simplify your calculations, assume the total firm value used in computing WACC does not have to consider the change in firm value due solely to the change in total cost of capital) Current WACC = 8.92% New WACC = 9.11%
4 10. Capital Structure. GE Corp. is examining its capital structure with the intent of arriving at an optimal debt ratio. It currently has no debt and has a beta of 1.5. The riskless interest rate is 9%, and the risk premium is 8.3%. Your research indicates that the debt rating will as follows at different debt levels: D/(D+E) Rating Interest rate 0% AAA 10% 10% AA 10.5% 20% A 11% 30% BBB 12% 40% BB 13% 50% B 14% 60% CCC 16% 70% CC 18% 80% C 20% 90% D 25% The firm currently has 1 million shares outstanding at $ 20 per share. (Tax rate = 40%) What is the firm's optimal debt ratio? Beta with no debt is D E Beta Cost of Cost of WACC equity debt optimal 11. Long term financing. You are analyzing a convertible preferred stock, with the following characteristics for the security: There are 50,000 preferred shares outstanding, with a face value of $100 and a 6% preferred dividend rate. The firm has straight preferred stock outstanding, with a preferred dividend rate of 9%. The preferred stock is trading at $105. Estimate the preferred stock and equity components of this preferred stock. Value of Straight Preferred Stock portion of Convertible = Value of Conversion Portion = Measuring Risk. Chrysler, the automotive manufacturer, had a beta of 1.05 in It had $13 billion in debt outstanding in that year, and 355 million shares trading at $50 per share. The firm had a cash balance of $8 billion at the end of The marginal tax rate was 36% a. Estimate the unlevered beta of the firm. b. Estimate the effect of paying out a special dividend of $5 billion on this unlevered beta. c. Estimate the beta for Chrysler after the special dividend. a. b Utotal =.715 b. b U,auto =.966 New b U = c. New b L = 1.41
5 13. Cost of capital The Limited Group s assets have a total market value of $1,000 million. $600 million of the asset value is in the company's clothing division, which has an unlevered beta of 1.2. The other $400 million of the asset value is in the company's specialty retailing division. The company s equity (levered) beta is 1.8. The company s current outstanding debt is worth $250 million. $200 million of this debt is allocated to the clothing division. The rest of the debt is in the specialty retail division. The company has just announced the acquisition of RK Shoes, a small footwear company. RK is a private company and has no debt in its capital structure. The Limited s investment bankers estimate that RK has a beta of 1.5. The Limited is going to raise the necessary $50 million for the acquisition by issuing new debt. This new debt, as well as the newly acquired assets, will be allocated to The Limited s specialty retailing division. What are The Limited s divisional asset (unlevered) betas after the acquisition? What will the beta be for the company s stock after the acquisition? Assume that The Limited has a 40% tax rate. b unlevered,clothing = 1.2 b U,new SR = 1.90 New levered beta: b L = = Risk & Return You run a regression of XYZ stock returns against the market returns using monthly observation over a fiveyear period. You had an intercept of 0.20% and a slope of Over this time period, XYZ s stock return had an annualized standard deviation of 40% whereas the market standard deviation was only 20%. The risk free rate has been 6% on average over the last five years, and currently it is at 7%. The historical risk premium has been 8.5%. The annualized dividend per share currently is $2.00, and the stock is currently selling at $50. There are 100,000 shares outstanding. (a) What proportion of XYZ risk is diversifiable? (b) What would you expect XYZ s stock price to be one year from today? (c) XYZ currently has $5 million in debt outstanding and its marginal tax rate is %40. XYZ is planning on selling one of its divisions for $5 million. This division has an asset beta of 0.5. XYZ will use the proceeds from the sale to pay $3 million as dividends to its stockholders. The rest will be used to retire debt. What will the beta be after this restructuring? (a) 1  R 2 = 0.64 (b) P 1 = $56.6 (c) b AFTER = 1.9 diversifiable risk
6 full solutions 1) Portfolio risk and return IS = ( )/5 = 4.4 DS = ( )/5 = 4.6 s 2 IS =.2{( ) 2 +( ) 2 +( ) 2 +( ) 2 +( ) 2 } = s 2 DS =.2{( ) 2 +( ) 2 +( ) 2 +( ) 2 +( ) 2 } = s DS = {( )( )+ ( )( )+ ( )( )+ ( )( )+ ( )( )} = r IS,DS = ( )/( ) ( ) = r p =.5*4.4+.5*4.6=4.5 s P = {.5 2 * * *.5*.5* } 1/2 = ) CAPM r m =.145 r f =.07 b k = 1.2 E(r k ) = ( ) =.162 P = (5*1.01)/( ) = b. E(r MX ) =.15 b MX = st. Compare risk reward ratios: Market (r m r f )/ b m =.085 Kindercare (r K r f )/ b K = ( )/1.2 =.085 Maxicare (r MK r f )/ b MX = ( )/1.5 =.06 expected return is too low relative to systematic risk, dont buy Maxicare. Or, 2 nd from CAPM: E(r MX ) = *( ) =.1875 Since return is lower than that predicted by CAPM (below security market line), don t buy it. 3) CAPM s zm =r zm s z s m =.2*.1*.12 =.0024 b Z =s zm /s 2 m =.0024/.1 2 =.24 r z = *( ) =7.54%
7 4. Cost of capital D: $100M. FV, 10% coupon rate, semiannual pmts. 10 yrs to maturity, YTM 8% MV DEBT = $5/0.04 [11/ ] + $100/(1.04) 20 = M MV EQUITY = (1 M)( $50) = $ 50 M MV FIRM = = b = 1.5 TBill rate = 5% Riskpremium = 8.5 % T = 40% r e = 5% + (1.5)(8.5%) = 17.75% r WACC = (50/163.59) * (17.75%) + (113.59/163.59) * (10.4) * (8%) = 8.76% 5. Risk & Return: Estimating beta. ave beta = 1.1 ; ave D/E =.327 b unlev = 1.1/[1+.327(1.35)] = Cost of capital a. Unlever coffee beta: 1.3/(1+(1.36).6)=.9393 Unlever Einstein beta:.9/(1+(1.36).8) =.595 New Einstein unlevered beta: 80%* %*.9393 = New Einstein levered beta:.66(1+(1.36).8)=1 b. cost of capital: r d =.11 r e = *.055 =.125 D/V =.8/1.8 =.444 E/V = 1/1.8 =.556
8 WACC =.8/1.8*.11*(1.36) + 1/1.8*.125 = 10.07% 7. Capital Structure: Modigliani Miller Theorems a. V L = V U + T C B = EBIT(1T C )/r 0 + T C B = $8(.66)/ *$15 = $49.1 b. R S =r 0 +B/S(r 0 r B )(1T C ) =.12 + [15/( )]*( )*.66 = 13.16% 8. Capital Structure Theory a. i. New firm value: $640,000 (MM Prop I) ii. Share price = 640,000/32,000 = $20/share Number of shares repurchased = 300,000/20 = 15,000 Capital structure = D + E = 300, ,000 MVE = 340,000 Number of shares outstanding = 32,00015,000 = 17,000 Share price = $20/share b. Original firm value = 5,000*7 = 35,000 Tax shield = T c B =.25(10,000) = 2,500 New firm value = 37,500 37,500 = D+E = 10,000 + E ; E = 27, Capital Structure. Current value of equity = $400 million Current value of debt = $250 million Cost of equity = *.055 = 11.5% Cost of debt = 8% Current WACC = 250/650*8%*(1.4) + 400/650*11.5% = 8.92% NPV of project accrues to equity, so Equity = $400 $30  $80 + $30 = $320 Debt = $250 + $150 = $400 New D/E ratio = 400/320 Unlevered beta = 1/(1+0.6*250/400) = New levered beta = 0.727*(1+0.6*400/320)) = 1.27 New cost of equity = *.055 = 13% New WACC = 400/720*10%*(1.4) + 320/720*13% = 9.11% 10. Capital Structure. Beta with no debt is Need to calculate new beta as D/E changes. D E Beta Cost of Cost of WACC equity debt
9 optimal Long term financing. Value of Straight Preferred Stock portion of Convertible = 6/.09 = $ 66.67! Perpetual Life Value of Conversion Portion = $ $ = $ Measuring Risk. Before Cash 8 billion D=13 billion Auto E=17.75 billion billion b unlevered = 1.05/[1+13/17.75*(1.36)] =.715 b cash = 0 b U =.715 = b U,auto *22.75/ b cash *8/30.75 b U,auto =.966 After Cash 3 billion Auto billion D=13 billion E=12.75 billion New b U = b U,auto *22.75/ b cash *3/25.75 = New b L = 0.853*[1+13/12.75*(1.36)] = Cost of capital b Levered,CLOTHING+SR = 1.8 b unlevered,clothing = 1.2 b RK = 1.5 BEFORE A: $600M D: $200M (Clothing division) E: $400M
10 A: $400M (SR division) D: $50 E: $350 AFTER A: $600M D: $200M (Clothing division) E: $400M A: $450M (SR division) D: $100 E: $350 b L = b U * 1+ (1 T) D E = b U,COTHING+SR * b U,CLOTHING+SR = 1.50 before. 750 b U,CLOTHING+SR = 1.5 = 600/1000 * /1000 * b U,SR ; b U,SR = 1.95 After, b U,new SR = 400/450 * /450 * 1.5 = 1.90 So asset beta for new SR division = 1.90; asset beta for clothing division equals original 1.2 New levered beta:, b U,new total = 600/1050 * /1050 * 1.9 = b L = 1.50 * = Risk & Return a = 0.30%, b= 1.20 R i = r f + B(r m  r f ) = (1B) r f + Br m s xyz = 0.4, s m = 0.2 r f = 6% (historical) (7% now) r f  r m = 8.5% D = $2/share P o = $50 n = 100,000 shares (a) R 2 = b 2 s m 2 /s xyz 2 = (0.2) 2 /(0.4) 2 = 0.36 systematic
11 1  R 2 = = 0.64 diversifiable risk (b) r xyz = 7% + 1.2(8.5%) = 17.2% (P ) / 50 = 17.2 % P 1 = $56.6 (c) Before A = $10 M D = $5 M E = 100,000 * 50 = $5 M b E = 1.2 ; 1.2 = b u * [ (5/5) ] b u = 0.75 b u = 0.75 = 1/2 (0.5) + 1/2 b u, 2 b u,2 = 1 After A = $5 M D = $3M E = $2 M b AFTER = (1) * [ (3/2) ] = 1.9
12 additional problems done in class: Quick Mart is a small convenience store thinking of adding a donut shop in the store to serve their commuting customs breakfast. They have complied the following information on companies in the donut business: Comparable firm Beta Debt/Equity ratio Krispy Crème Dunkin Donut H&H The appropriate corporate tax rate is 34%, and Quick Mart s management has set a target D/E ratio of.3 for the donut project. The market risk premium is 6%, and the risk free rate is 5%. a. Estimate an unlevered beta using the comparable firms. b. Estimate the levered beta for the new project. c. Estimate the cost of equity for the donut shop. Solution Average beta=1.4 Average D/E= Unlevered beta=1.4/(1+(10.34)*0.4822)= *(1+(10.34)*0.3)= *0.06=0.1263
13 Measuring risk You have run a regression of AB Corp s stock returns against the market and determined its equity beta is 1.5. The company has, in market value terms, $500 million of debt and $500 million of equity. The company currently has two divisions. Division A, which has a market value of $600 million, produces disk drives and you find 5 listed companies on the NYSE which made only disk drives. These companies have an average beta of 1.31 and an average debt equity ratio of 20%. Division B produces memory chips and you cannot find any comparable companies. Assume all companies face a tax rate of 50%. a. What is the asset (unlevered) beta for division B? b. If the company divests itself of Division B and increases its debt equity ratio to 2, what would the company s beta be? Solution β L,AB =1.5 A=600 D=500 B=400 E=500 β L,Acomps =1.31 D/E of Acomps =0.2 β U,Acomps =1.31/[1+(10.5)*0.2]=1.31/1.1=1.19 β U,AB =1.5/[1+(10.5)*1]=1 1=β U,AB =600/1000*β U,A +400/1000*β U,B =0.6* *β U,B β U,B =0.715 β L,A =β U,A *[1+(10.5)*2]=1.19*2=2.38
EXAM 1 REVIEW QUESTIONS
EXAM 1 REVIEW QUESTIONS 1) Free cash flow. Consider the following financial statements for United Technologies Corp. What is UT's free cash flow (total cash flow from assets) for 2001? UNITED TECHNOLOGIES:
More informationSOLUTIONS. Practice questions. Multiple Choice
Practice questions Multiple Choice 1. XYZ has $25,000 of debt outstanding and a book value of equity of $25,000. The company has 10,000 shares outstanding and a stock price of $10. If the unlevered beta
More informationChapter 17 Does Debt Policy Matter?
Chapter 17 Does Debt Policy Matter? Multiple Choice Questions 1. When a firm has no debt, then such a firm is known as: (I) an unlevered firm (II) a levered firm (III) an allequity firm D) I and III only
More informationUse the table for the questions 18 and 19 below.
Use the table for the questions 18 and 19 below. The following table summarizes prices of various defaultfree zerocoupon bonds (expressed as a percentage of face value): Maturity (years) 1 3 4 5 Price
More informationCHAPTER 8. Problems and Questions
CHAPTER 8 Problems and Questions 1. Plastico, a manufacturer of consumer plastic products, is evaluating its capital structure. The balance sheet of the company is as follows (in millions): Assets Liabilities
More informationFinancial Markets and Valuation  Tutorial 6: SOLUTIONS. Capital Structure and Cost of Funds
Financial Markets and Valuation  Tutorial 6: SOLUTIONS Capital Structure and Cost of Funds (*) denotes those problems to be covered in detail during the tutorial session (*) Problem 1. (Ross, Westerfield
More informationDUKE UNIVERSITY Fuqua School of Business. FINANCE 351  CORPORATE FINANCE Problem Set #4 Prof. Simon Gervais Fall 2011 Term 2.
DUK UNIRSITY Fuqua School of Business FINANC 351  CORPORAT FINANC Problem Set #4 Prof. Simon Gervais Fall 2011 Term 2 Questions 1. Suppose the corporate tax rate is 40%. Consider a firm that earns $1,000
More informationt = 1 2 3 1. Calculate the implied interest rates and graph the term structure of interest rates. t = 1 2 3 X t = 100 100 100 t = 1 2 3
MØA 155 PROBLEM SET: Summarizing Exercise 1. Present Value [3] You are given the following prices P t today for receiving risk free payments t periods from now. t = 1 2 3 P t = 0.95 0.9 0.85 1. Calculate
More informationTest3. Pessimistic Most Likely Optimistic Total Revenues 30 50 65 Total Costs 2520 15
Test3 1. The market value of Charcoal Corporation's common stock is $20 million, and the market value of its riskfree debt is $5 million. The beta of the company's common stock is 1.25, and the market
More informationIf you ignore taxes in this problem and there is no debt outstanding: EPS = EBIT/shares outstanding = $14,000/2,500 = $5.60
Problems Relating to Capital Structure and Leverage 1. EBIT and Leverage Money Inc., has no debt outstanding and a total market value of $150,000. Earnings before interest and taxes [EBIT] are projected
More informationChapter 17 Corporate Capital Structure Foundations (Sections 17.1 and 17.2. Skim section 17.3.)
Chapter 17 Corporate Capital Structure Foundations (Sections 17.1 and 17.2. Skim section 17.3.) The primary focus of the next two chapters will be to examine the debt/equity choice by firms. In particular,
More informationFINC 3630: Advanced Business Finance Additional Practice Problems
FINC 3630: Advanced Business Finance Additional Practice Problems Accounting For Financial Management 1. Calculate free cash flow for Home Depot for the fiscal yearended February 1, 2015 (the 2014 fiscal
More informationChapter 14 Capital Structure in a Perfect Market
Chapter 14 Capital Structure in a Perfect Market 141. Consider a project with free cash flows in one year of $130,000 or $180,000, with each outcome being equally likely. The initial investment required
More informationProblem 1 Problem 2 Problem 3
Problem 1 (1) Book Value Debt/Equity Ratio = 2500/2500 = 100% Market Value of Equity = 50 million * $ 80 = $4,000 Market Value of Debt =.80 * 2500 = $2,000 Debt/Equity Ratio in market value terms = 2000/4000
More information1. CFI Holdings is a conglomerate listed on the Zimbabwe Stock Exchange (ZSE) and has three operating divisions as follows:
NATIONAL UNIVERSITY OF SCIENCE AND TECHNOLOGY FACULTY OF COMMERCE DEPARTMENT OF FINANCE BACHELOR OF COMMERCE HONOURS DEGREE IN FINANCE PART II 2 ND SEMESTER FINAL EXAMINATION MAY 2005 CORPORATE FINANCE
More informationLeverage. FINANCE 350 Global Financial Management. Professor Alon Brav Fuqua School of Business Duke University. Overview
Leverage FINANCE 35 Global Financial Management Professor Alon Brav Fuqua School of Business Duke University Overview Capital Structure does not matter! Modigliani & Miller propositions Implications for
More informationCorporate Finance: Final Exam
Corporate Finance: Final Exam Answer all questions and show necessary work. Please be brief. This is an open books, open notes exam. 1. DayTop Inns is a publicly traded company, with 10 million shares
More informationModels of Risk and Return
Models of Risk and Return Aswath Damodaran Aswath Damodaran 1 First Principles Invest in projects that yield a return greater than the minimum acceptable hurdle rate. The hurdle rate should be higher for
More information1 Pricing options using the Black Scholes formula
Lecture 9 Pricing options using the Black Scholes formula Exercise. Consider month options with exercise prices of K = 45. The variance of the underlying security is σ 2 = 0.20. The risk free interest
More informationDUKE UNIVERSITY Fuqua School of Business. FINANCE 351  CORPORATE FINANCE Problem Set #7 Prof. Simon Gervais Fall 2011 Term 2.
DUKE UNIVERSITY Fuqua School of Business FINANCE 351  CORPORATE FINANCE Problem Set #7 Prof. Simon Gervais Fall 2011 Term 2 Questions 1. Suppose the corporate tax rate is 40%, and investors pay a tax
More informationI. Estimating Discount Rates
I. Estimating Discount Rates DCF Valuation Aswath Damodaran 1 Estimating Inputs: Discount Rates Critical ingredient in discounted cashflow valuation. Errors in estimating the discount rate or mismatching
More informationHomework Solutions  Lecture 2
Homework Solutions  Lecture 2 1. The value of the S&P 500 index is 1286.12 and the treasury rate is 3.43%. In a typical year, stock repurchases increase the average payout ratio on S&P 500 stocks to over
More informationPractice Exam (Solutions)
Practice Exam (Solutions) June 6, 2008 Course: Finance for AEO Length: 2 hours Lecturer: Paul Sengmüller Students are expected to conduct themselves properly during examinations and to obey any instructions
More informationFinal Exam MØA 155 Financial Economics Fall 2009 Permitted Material: Calculator
University of Stavanger (UiS) Stavanger Masters Program Final Exam MØA 155 Financial Economics Fall 2009 Permitted Material: Calculator The number in brackets is the weight for each problem. The weights
More informationFinance 3130 Corporate Finiance Sample Final Exam Spring 2012
Finance 3130 Corporate Finiance Sample Final Exam Spring 2012 True/False Indicate whether the statement is true or falsewith A for true and B for false. 1. Interest paid by a corporation is a tax deduction
More informationBonds, Preferred Stock, and Common Stock
Bonds, Preferred Stock, and Common Stock I. Bonds 1. An investor has a required rate of return of 4% on a 1year discount bond with a $100 face value. What is the most the investor would pay for 2. An
More informationCost of Capital and Project Valuation
Cost of Capital and Project Valuation 1 Background Firm organization There are four types: sole proprietorships partnerships limited liability companies corporations Each organizational form has different
More informationCorporate Finance: Final Exam
Corporate Finance: Final Exam Answer all questions and show necessary work. Please be brief. This is an open books, open notes exam. For partial credit, when discounting, please show the discount rate
More informationEstimating Beta. Aswath Damodaran
Estimating Beta The standard procedure for estimating betas is to regress stock returns (R j ) against market returns (R m )  R j = a + b R m where a is the intercept and b is the slope of the regression.
More informationThe Tangent or Efficient Portfolio
The Tangent or Efficient Portfolio 1 2 Identifying the Tangent Portfolio Sharpe Ratio: Measures the ratio of rewardtovolatility provided by a portfolio Sharpe Ratio Portfolio Excess Return E[ RP ] r
More informationLeverage and Capital Structure
Leverage and Capital Structure Ross Chapter 16 Spring 2005 10.1 Leverage Financial Leverage Financial leverage is the use of fixed financial costs to magnify the effect of changes in EBIT on EPS. Fixed
More informationExercise. Exam Aid: All calculators are allowed but empty memory. Paper dictionaries are allowed. No other aids allowed in the exam room.
Exercise Exam Aid: All calculators are allowed but empty memory. Paper dictionaries are allowed. No other aids allowed in the exam room. Note: No formula sheets are allowed in the exam. Exercise: 01 Exercise
More informationTPPE17 Corporate Finance 1(5) SOLUTIONS REEXAMS 2014 II + III
TPPE17 Corporate Finance 1(5) SOLUTIONS REEXAMS 2014 II III Instructions 1. Only one problem should be treated on each sheet of paper and only one side of the sheet should be used. 2. The solutions folder
More informationM.I.T. Spring 1999 Sloan School of Management 15.415. First Half Summary
M.I.T. Spring 1999 Sloan School of Management 15.415 First Half Summary Present Values Basic Idea: We should discount future cash flows. The appropriate discount rate is the opportunity cost of capital.
More informationSAMPLE FACT EXAM (You must score 70% to successfully clear FACT)
SAMPLE FACT EXAM (You must score 70% to successfully clear FACT) 1. What is the present value (PV) of $100,000 received five years from now, assuming the interest rate is 8% per year? a. $600,000.00 b.
More informationCHAPTER 12 RISK, COST OF CAPITAL, AND CAPITAL BUDGETING
CHAPTER 12 RISK, COST OF CAPITAL, AND CAPITAL BUDGETING Answers to Concepts Review and Critical Thinking Questions 1. No. The cost of capital depends on the risk of the project, not the source of the money.
More informationPicking the Right Investments: Investment Analysis
Picking the Right Investments: Investment Analysis Aswath Damodaran Aswath Damodaran 1 First Principles Invest in projects that yield a return greater than the minimum acceptable hurdle rate. The hurdle
More informationCHAPTER 14 COST OF CAPITAL
CHAPTER 14 COST OF CAPITAL Answers to Concepts Review and Critical Thinking Questions 1. It is the minimum rate of return the firm must earn overall on its existing assets. If it earns more than this,
More informationFinding the Right Financing Mix: The Capital Structure Decision
Finding the Right Financing Mix: The Capital Structure Decision Aswath Damodaran Stern School of Business Aswath Damodaran 1 First Principles Invest in projects that yield a return greater than the minimum
More informationKEY EQUATIONS APPENDIX CHAPTER 2 CHAPTER 3
KEY EQUATIONS B CHAPTER 2 1. The balance sheet identity or equation: Assets Liabilities Shareholders equity [2.1] 2. The income statement equation: Revenues Expenses Income [2.2] 3.The cash flow identity:
More informationFIN 432 Investment Analysis and Management Review Notes for Midterm Exam
FIN 432 Investment Analysis and Management Review Notes for Midterm Exam Chapter 1 1. Investment vs. investments 2. Real assets vs. financial assets 3. Investment process Investment policy, asset allocation,
More informationMGT201 Solved MCQs(500) By
MGT201 Solved MCQs(500) By http://www.vustudents.net Why companies invest in projects with negative NPV? Because there is hidden value in each project Because there may be chance of rapid growth Because
More informationThings to Absorb, Read, and Do
Things to Absorb, Read, and Do Things to absorb  Everything, plus remember some material from previous chapters. This chapter applies Chapter s 6, 7, and 12, Risk and Return concepts to the market value
More informationE. V. Bulyatkin CAPITAL STRUCTURE
E. V. Bulyatkin Graduate Student Edinburgh University Business School CAPITAL STRUCTURE Abstract. This paper aims to analyze the current capital structure of Lufthansa in order to increase market value
More informationCost of Capital, Valuation and Strategic Financial Decision Making
Cost of Capital, Valuation and Strategic Financial Decision Making By Dr. Valerio Poti,  Examiner in Professional 2 Stage Strategic Corporate Finance The financial crisis that hit financial markets in
More informationBUSINESS FINANCE (FIN 312) Spring 2008
BUSINESS FINANCE (FIN 312) Spring 2008 Assignment 3 Instructions: please read carefully You can either do the assignment by yourself or work in a group of no more than two. You should show your work how
More informationTopics in Chapter. Key features of bonds Bond valuation Measuring yield Assessing risk
Bond Valuation 1 Topics in Chapter Key features of bonds Bond valuation Measuring yield Assessing risk 2 Determinants of Intrinsic Value: The Cost of Debt Net operating profit after taxes Free cash flow
More informationChapter 13, ROIC and WACC
Chapter 13, ROIC and WACC Lakehead University Winter 2005 Role of the CFO The Chief Financial Officer (CFO) is involved in the following decisions: Management Decisions Financing Decisions Investment Decisions
More informationThe cost of capital. A reading prepared by Pamela Peterson Drake. 1. Introduction
The cost of capital A reading prepared by Pamela Peterson Drake O U T L I N E 1. Introduction... 1 2. Determining the proportions of each source of capital that will be raised... 3 3. Estimating the marginal
More informationCalculating the weighted average cost of capital for the telephone industry in Russia
Calculating the weighted average cost of capital for the telephone industry in Russia Abstract: John Gardner University of New Orleans Carl McGowan, Jr. Norfolk State University Susan Moeller Eastern Michigan
More informationNIKE Case Study Solutions
NIKE Case Study Solutions Professor Corwin This case study includes several problems related to the valuation of Nike. We will work through these problems throughout the course to demonstrate some of the
More informationChapter 7: Capital Structure: An Overview of the Financing Decision
Chapter 7: Capital Structure: An Overview of the Financing Decision 1. Income bonds are similar to preferred stock in several ways. Payment of interest on income bonds depends on the availability of sufficient
More informationReview for Exam 2. Instructions: Please read carefully
Review for Exam 2 Instructions: Please read carefully The exam will have 25 multiple choice questions and 5 work problems You are not responsible for any topics that are not covered in the lecture note
More informationStock Valuation: Gordon Growth Model. Week 2
Stock Valuation: Gordon Growth Model Week 2 Approaches to Valuation 1. Discounted Cash Flow Valuation The value of an asset is the sum of the discounted cash flows. 2. Contingent Claim Valuation A contingent
More informationGESTÃO FINANCEIRA II PROBLEM SET 5 SOLUTIONS (FROM BERK AND DEMARZO S CORPORATE FINANCE ) LICENCIATURA UNDERGRADUATE COURSE
GESTÃO FINANCEIRA II PROBLEM SET 5 SOLUTIONS (FROM BERK AND DEMARZO S CORPORATE FINANCE ) LICENCIATURA UNDERGRADUATE COURSE 1 ST SEMESTER 20102011 Chapter 18 Capital Budgeting and Valuation with Leverage
More informationMakeup Exam MØA 155 Financial Economics February 2010 Permitted Material: Calculator, Norwegian/English Dictionary
University of Stavanger (UiS) Stavanger Masters Program Makeup Exam MØA 155 Financial Economics February 2010 Permitted Material: Calculator, Norwegian/English Dictionary The number in brackets is the
More informationDiscounted Cash Flow Valuation: The Inputs. Aswath Damodaran
Discounted Cash Flow Valuation: The Inputs Aswath Damodaran 1 The Key Inputs in DCF Valuation Discount Rate Cost of Equity, in valuing equity Cost of Capital, in valuing the firm Cash Flows Cash Flows
More informationChapter 7. . 1. component of the convertible can be estimated as 1100796.15 = 303.85.
Chapter 7 71 Income bonds do share some characteristics with preferred stock. The primary difference is that interest paid on income bonds is tax deductible while preferred dividends are not. Income bondholders
More informationChapter 7 Risk, Return, and the Capital Asset Pricing Model
Chapter 7 Risk, Return, and the Capital Asset Pricing Model MULTIPLE CHOICE 1. Suppose Sarah can borrow and lend at the risk freerate of 3%. Which of the following four risky portfolios should she hold
More informationSAMPLE MIDTERM QUESTIONS
SAMPLE MIDTERM QUESTIONS William L. Silber HOW TO PREPARE FOR THE MID TERM: 1. Study in a group 2. Review the concept questions in the Before and After book 3. When you review the questions listed below,
More informationCIS September 2012 Exam Diet. Examination Paper 2.2: Corporate Finance Equity Valuation and Analysis Fixed Income Valuation and Analysis
CIS September 2012 Exam Diet Examination Paper 2.2: Corporate Finance Equity Valuation and Analysis Fixed Income Valuation and Analysis Corporate Finance (1 13) 1. Assume a firm issues N1 billion in debt
More informationChapter 10 Risk and Capital Budgeting
Chapter 10 Risk and Capital Budgeting MULTIPLE CHOICE 1. Operating leverage describes the relationship between... a. EBIT and sales b. taxes and sales c. debt and equity d. fixed costs and variable costs
More informationCOST OF CAPITAL Compute the cost of debt. Compute the cost of preferred stock.
OBJECTIVE 1 Compute the cost of debt. The method of computing the yield to maturity for bonds will be used how to compute the cost of debt. Because interest payments are tax deductible, only aftertax
More informationYou just paid $350,000 for a policy that will pay you and your heirs $12,000 a year forever. What rate of return are you earning on this policy?
1 You estimate that you will have $24,500 in student loans by the time you graduate. The interest rate is 6.5%. If you want to have this debt paid in full within five years, how much must you pay each
More informationCHAPTER 15 Capital Structure: Basic Concepts
Multiple Choice Questions: CHAPTER 15 Capital Structure: Basic Concepts I. DEFINITIONS HOMEMADE LEVERAGE a 1. The use of personal borrowing to change the overall amount of financial leverage to which an
More informationCIS September 2013 Exam Diet Examination Paper 2.2: Corporate Finance Equity Valuation and Analysis Fixed Income Valuation and Analysis Level 2
CIS September 2013 Exam Diet Examination Paper 2.2: Corporate Finance Equity Valuation and Analysis Fixed Income Valuation and Analysis Level 2 SECTION A: MULTIPLE CHOICE QUESTIONS Corporate Finance (1
More information] (3.3) ] (1 + r)t (3.4)
Present value = future value after t periods (3.1) (1 + r) t PV of perpetuity = C = cash payment (3.2) r interest rate Present value of tyear annuity = C [ 1 1 ] (3.3) r r(1 + r) t Future value of annuity
More informationExecutive Summary of Finance 430 Professor VissingJørgensen Finance 43062/63/64, Winter 2011
Executive Summary of Finance 430 Professor VissingJørgensen Finance 43062/63/64, Winter 2011 Weekly Topics: 1. Present and Future Values, Annuities and Perpetuities 2. More on NPV 3. Capital Budgeting
More informationCHAPTER 2 How to Calculate Present Values
CHAPTER How to Calculate Present Values 0. Mr. Basset is buying a security worth $0,000 now, which is its present value. The unknown is the annual payment. Using the present value of an annuity formula,
More informationFinding the Right Financing Mix: The Capital Structure Decision
Finding the Right Financing Mix: The Capital Structure Decision Aswath Damodaran Stern School of Business Aswath Damodaran 1 First Principles Invest in projects that yield a return greater than the minimum
More informationPractice Questions for Midterm II
Finance 333 Investments Practice Questions for Midterm II Winter 2004 Professor Yan 1. The market portfolio has a beta of a. 0. *b. 1. c. 1. d. 0.5. By definition, the beta of the market portfolio is
More informationFinance 2 for IBA (30J201) F. Feriozzi Resit exam June 18 th, 2012. Part One: MultipleChoice Questions (45 points)
Finance 2 for IBA (30J201) F. Feriozzi Resit exam June 18 th, 2012 Part One: MultipleChoice Questions (45 points) Question 1 Assume that capital markets are perfect. Which of the following statements
More informationBF 6701 : Financial Management Comprehensive Examination Guideline
BF 6701 : Financial Management Comprehensive Examination Guideline 1) There will be 5 essay questions and 5 calculation questions to be completed in 1hour exam. 2) The topics included in those essay and
More informationCAPITAL STRUCTURE [Chapter 15 and Chapter 16]
Capital Structure [CHAP. 15 & 16] 1 CAPITAL STRUCTURE [Chapter 15 and Chapter 16] CONTENTS I. Introduction II. Capital Structure & Firm Value WITHOUT Taxes III. Capital Structure & Firm Value WITH Corporate
More informationInterest Rates and Bond Valuation
Interest Rates and Bond Valuation Chapter 6 Key Concepts and Skills Know the important bond features and bond types Understand bond values and why they fluctuate Understand bond ratings and what they mean
More informationFinding the Right Financing Mix: The Capital Structure Decision
Finding the Right Financing Mix: The Capital Structure Decision Neither a borrower nor a lender be Someone who obviously hated this part of corporate finance Aswath Damodaran 2 First Principles Invest
More informationMidterm Exam:Answer Sheet
Econ 497 Barry W. Ickes Spring 2007 Midterm Exam:Answer Sheet 1. (25%) Consider a portfolio, c, comprised of a riskfree and risky asset, with returns given by r f and E(r p ), respectively. Let y be the
More informationCOST OF CAPITAL. Please note that in finance, we are concerned with MARKET VALUES (unlike accounting, which is concerned with book values).
COST OF CAPITAL Cost of capital calculations are a very important part of finance. To value a project, it is important to discount the cash flows using a discount rate that incorporates the debtequity
More information3. If an individual investor buys or sells a currently owned stock through a broker, this is a primary market transaction.
Spring 2012 Finance 3130 Sample Exam 1A Questions for Review 1. The form of organization for a business is an important issue, as this decision has very significant effect on the income and wealth of the
More informationChapter 11. Stocks and Bonds. How does this distribution work? An example. What form do the distributions to common shareholders take?
Chapter 11. Stocks and Bonds Chapter Objectives To identify basic shareholder rights and the means by which corporations make distributions to shareholders To recognize the investment opportunities in
More informationINVESTMENTS IN OFFSHORE OIL AND NATURAL GAS DEPOSITS IN ISRAEL: BASIC PRINCIPLES ROBERT S. PINDYCK
INVESTMENTS IN OFFSHORE OIL AND NATURAL GAS DEPOSITS IN ISRAEL: BASIC PRINCIPLES ROBERT S. PINDYCK Bank of TokyoMitsubishi Professor of Economics and Finance Sloan School of Management Massachusetts Institute
More informationChapter 11 Calculating the Cost of Capital
Chapter 11 Calculating the Cost of Capital (def)  Cost of obtaining money to fund asset purchase  use as estimate of r (discount rate) If we can earn more than the cost of capital (r) from a project
More informationMidland Energy/Sample 2. Midland Energy Resources, Inc.
Midland Energy Resources, Inc. Midland Energy Resources, Inc. is a global energy company that operates in oil and gas exploration and production (E&P), refining and marketing (R&M), and petrochemicals.
More informationThe Adjusted Present Value Approach to Valuing Leveraged Buyouts 1
Chapter 17 Valuation and Capital Budgeting for the Levered Firm 17A1 Appendix 17A The Adjusted Present Value Approach to Valuing Leveraged Buyouts 1 Introduction A leveraged buyout (LBO) is the acquisition
More informationCHAPTER 10 RISK AND RETURN: THE CAPITAL ASSET PRICING MODEL (CAPM)
CHAPTER 10 RISK AND RETURN: THE CAPITAL ASSET PRICING MODEL (CAPM) Answers to Concepts Review and Critical Thinking Questions 1. Some of the risk in holding any asset is unique to the asset in question.
More informationThe Adjusted Present Value Approach to Valuing Leveraged Buyouts 1 Introduction
Chapter 18 Valuation and Capital Budgeting for the Levered Firm 18A1 Appendix 18A The Adjusted Present Value Approach to Valuing Leveraged Buyouts 1 Introduction A leveraged buyout (LBO) is the acquisition
More informationPart 9. The Basics of Corporate Finance
Part 9. The Basics of Corporate Finance The essence of business is to raise money from investors to fund projects that will return more money to the investors. To do this, there are three financial questions
More informationOption Pricing Applications in Valuation!
Option Pricing Applications in Valuation! Equity Value in Deeply Troubled Firms Value of Undeveloped Reserves for Natural Resource Firm Value of Patent/License 73 Option Pricing Applications in Equity
More informationPRACTICE EXAM QUESTIONS ON WACC
Dr. Sudhakar Raju Financial Statements Analysis (FN 6450) PRACTICE EXAM QUESTIONS ON WACC 1. The return shareholders require on their investment in a firm is called the: a. dividend yield. B. cost of equity.
More informationFinancialInstitutions Management
Solutions 3 Chapter 11: Credit Risk Loan Pricing and Terms 9. County Bank offers oneyear loans with a stated rate of 9 percent but requires a compensating balance of 10 percent. What is the true cost
More informationAnatomy of a Leveraged Buyout: Leverage + Control + Going Private
Anatomy of a Leveraged Buyout: Leverage + Control + Going Private Aswath Damodaran Home Page: www.damodaran.com EMail: adamodar@stern.nyu.edu Stern School of Business Aswath Damodaran 1 Leveraged Buyouts:
More informationNapoli Pizza wants to determine its optimal capital structure
Napoli Pizza wants to determine its optimal capital structure ABSTRACT Brad Stevenson Daniel Bauer David Collins Keith Richardson This case is based on an actual business decision that was made by a small,
More informationTakeHome Problem Set
Georgia State University Department of Finance MBA 8622 Fall 2001 MBA 8622: Corporation Finance TakeHome Problem Set Instructors: Lalitha Naveen, N. Daniel, C.Hodges, A. Mettler, R. Morin, M. Shrikhande,
More informationCHAPTER 16. Financial Distress, Managerial Incentives, and Information. Chapter Synopsis
CHAPTER 16 Financial Distress, Managerial Incentives, and Information Chapter Synopsis In the previous two chapters it was shown that, in an otherwise perfect capital market in which firms pay taxes, the
More informationa) The Dividend Growth Model Approach: Recall the constant dividend growth model for the price of a rm s stock:
Cost of Capital Chapter 14 A) The Cost of Capital: Some Preliminaries: The Security market line (SML) and capital asset pricing model (CAPM) describe the relationship between systematic risk and expected
More informationCopyright 2009 Pearson Education Canada
The consequence of failing to adjust the discount rate for the risk implicit in projects is that the firm will accept highrisk projects, which usually have higher IRR due to their highrisk nature, and
More informationReview for Exam 2. Instructions: Please read carefully
Review for Exam Instructions: Please read carefully The exam will have 1 multiple choice questions and 5 work problems. Questions in the multiple choice section will be either concept or calculation questions.
More informationMBA (3rd Sem) 201314 MBA/29/FM302/T/ODD/1314
Full Marks : 70 MBA/29/FM302/T/ODD/1314 201314 MBA (3rd Sem) Paper Name : Corporate Finance Paper Code : FM302 Time : 3 Hours The figures in the righthand margin indicate marks. Candidates are required
More informationChapter 14 Assessing LongTerm Debt, Equity, and Capital Structure
I. Capital Structure (definitions) II. MM without Taxes (1958) III. MM with Taxes (1963) Chapter 14 Assessing LongTerm Debt, Equity, and Capital Structure IV. Financial Distress V. Business Risk VI. Financial
More information