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FINC 2012 Intermediate Corporate Finance

Final Exam Sample Questions

This documents includes the sample questions for you to practice with in order to better prepare for the final exam.

The first part (Part I) includes 10 multiple choice questions. Only ONE choice is correct to each question. You are required to pick the most appropriate answer.

The second part (Part II) includes 3 short answer questions. The question may require you to perform some simple calculation and provide some short arguments.

The questions in the final exam will be in similar format. The formula sheet will be provided. You can find the formula sheet shared in a sperate document. The answers to the practice questions are uploaded in both a word document and an excel sheet. Please practice with the questions on your own before checking out with the answers.

This document is protected by copyright. This document is strictly used for you to prepare for the final exam only. You are NOT allowed to distribute the material to anyone else.

Part I Multiple Choice Questions

1. What is its cost of equity if there are no taxes or other imperfections? The firm has a debt-to-equity ratio of 0.60. Its cost of debt is 8%. Its overall cost of capital is 12%.

A) 18%

B) 14.4%

C) 10%.

D) 13.5%

2. Which of the following is NOT an example of the financial distress game?

A) Cash in and Run

B) Playing for Time

C) Bait and Switch

D) Empire Building

3. Which of the following will tend to INCREASE the benefit of the interest tax shield given a progressive tax rate structure?

I An increase in tax rates

II A large tax loss carry forward

III A large depreciation tax deduction

IV A sizeable increase in taxable income

A) I and III only

B)  I and IV only

C) II and III only

D)  I, II, III and IV.

4. The corporate tax rate is 35%. The personal capital gain tax rate is 15%. The personal interest gain tax rate is 33%. The dividend payment tax rate is 15%. Given all the information above, which one of the following statements is CORRECT?

A) The relative advantage formula yields the value of 1.21.

B)  Since the  dividend payment  and  capital  gain tax rate  are  identical,  individual investors will be indifferent between dividend payment and stock repurchase.

C) The relative advantage formula yields the value of 1.14.

D) MM theory with corporate tax argues that, given the tax environment descried in the question, equity is preferred to debt.

5. Which of the following statement is TRUE about the financial planning?

A) Financial planning should attempt to minimize risk.

B) Financial planning is necessary because financing and investment decisions interact and should not be made independently.

C) Firms’ planning horizons rarely exceed three years.

D) Financial planning models should include as much detail as possible.

6. Which of the following is an example of a way in which companies can create value by exploiting real options?

A) Exercising in-the-money real options immediately

B) Abandoning good projects in favour of newer projects

C) Acting quickly to take on new projects, even if there is no cost to wait

D) Optimally delaying or abandoning projects

7. Which one of the following statement is CORRECT about the preferred stock?

A) Preferred stocks take priority over common stock when receiving dividends.

B) Preferred  stock holders gain  some voting rights  if the  corporation  fails to pay preferred dividend.

C) Preferred stock often has a pre-set dividend rate.

D) All of the choices.

8. Eureka has no debt on its balance sheet in 2020, but paid $1.6 million in taxes. Assume Eureka’s marginal tax rate is 25% and Eureka’s after tax borrowing cost is 4.5%. If Eureka were to issue permanent debt to reduce its taxes by $ 1 million per year forever, then the amount that Eureka needs to borrow is

A) $88.9 million

B) $35.6 million

C) $22.2 million

D) $66.7 million

9. The Sweet Melon Corp. has in total 100 shares trading on the market at $20 each. The book value of the total equity is $3500. The total market value of debt issuance is $4000. The expected return on total assets is 15% and the expected return on debt is 10%. What is the estimated expected return on equity?

A) 25%

B) 18.3%

C) 17.5%

D) None of the choices is correct

10. Brown Mine needs $1.2 billion of new equity. Market price is $25. Brown Mines decides to raise additional funds by offering the right to buy 4 new shares for 16 at $12 per share. With 100% subscription, what is value of each right?

A) $8

B) $ 10.4

C) $9.6

D) $16

Part II Short Answer Questions

Question I

a)   The stock price falls following the announcement of the new debt issuance. Could you use the trade-off theory to explain why this could happen?

b)  What   is   Economic   Value   Added   (EVA)   in   assessing   the   management’s performance? Point out one limitation of this measurement.

c)   It’s acceptable to use the Black–Scholes formula or binomial trees to value real     options, even though the options are not traded. Do you agree with this statement? What is the key assumption of the valuation method?

d)  Will the firm create value by increasing dividend payment because of the clientele effect?

Question II

Guaier Motors is presently an all equity firm. It needs to raise $2.5m in additional funds. After raising its funds, it expects perpetual EBIT to be $600,000. The firm’s unlevered cost of equity is 12% and its before tax cost of debt is 8%.

a)   If there are no corporate taxes, under M-M theory what is the value of Guaier Motors if it employs common stock to raise the needed funds?

b)  If there are no corporate taxes and Guaier Motors employs debt to raise the 50% of the firm value, what is the cost ofequity, the weighted average cost of capital and the value of the firm?

c)   If there are no corporate taxes and M-M theory holds, will investors prefer levered firm to the unlevered firm? Why?

d)  Will the presence of corporate taxes increase or decrease the firm value? Why?

Question III

Purple Tulip (PT) Corporation is a clothing retailer with a current share price of $10.00 and with 25 million shares outstanding. It has no debt. Suppose that PT announces plans to borrow $100 million in order to repurchase shares.

a)  Assuming  perfect  capital  markets,  what  is  the  share  price  for  PT  after  this announcement? And why?

b)  Suppose that PT pays corporate tax of 35% and that shareholders expect the change in debt to be permanent. Assuming that capital markets are perfect except for the existence of corporate taxes, what is the share price for PT immediately after this announcement?

c)   Suppose that PT pays corporate taxes of 35% and that shareholders expect the change in debt to be permanent. Assume that capital markets are perfect except for the existence of corporate taxes and financial distress costs. If the price of PT's stock rises to $10.85 per share immediately following the announcement, what is then the present value of PT's financial distress costs?

d)  What is the cause of financial distress cost? Give two examples.