Question 1 (10 marks)

(a) Briefly explain in 50 words why IPOs underperform over the long-run under the diversion of opinion hypothesis. (Your answer must be handwritten)

(b) Briefly explain in 50 words why IPOs underperform over the long-run under the window of opportunity hypothesis. (Your answer must be handwritten)

Question 2 (10 marks)

(a) Briefly explain in 50 words why the trade-off theory is better at explaining inter- industry variation in capital structure. (Your answer must be handwritten.)

(b) Briefly explain in 50 words why the pecking order theory is better at explaining intra- industry variation in capital structure. (Your answer must be handwritten.)

Question 3 (10 marks)

You are an analyst employed to evaluate a financial lease relating to a piece of machinery. You are provided with the following information:

The company accountant tells you the asset will be fully depreciated over its useful life and will have zero residual value. You are also told that the machine is integral to a      project that management has already decided the company will proceed with.

(a) What is the maximum lease payment that the company should be willing to pay? (Show your work. Your answer must be handwritten)

(b) If the lease payment required was greater than the amount documented in (a) what would be your advice to the company? (Your answer must be handwritten)

Question 4 (10 marks)

Coleman Ltd is a transport company that has been asked to assess an opportunity to    provide services to a mining company, Aztec Ltd, that extracts copper in Western          Australia. The 10-year contract provides that the cash flows paid to Coleman Ltd at the end of each of the 10 years of the contract are a function of the international price for  copper during only the first year of the contract. Specifically, if the average price of       copper in the first year is greater than a benchmark price, then the contract allows for  Coleman Ltd to be paid a net cash flow of $1,000,000 per annum over the life of the     contract. If the average price of copper in the first year of the contract is less than the   benchmark price, then Coleman Ltd enjoys a net cash flow of only $250,000 per annum over the life of the contract.

You estimate that there is a 60% chance that the price of copper will exceed the            benchmark rate in the first year of the contract. You also estimate that Coleman Ltd will have to invest $2 million initially to purchase the specialized transport equipment         necessary to service the contract.

As a final point, Coleman Ltd insist that they should have the right to walk away from     the contract at the end of the first year if the price of copper is below the benchmark     rate. In that case, you estimate that they would be able to sell their transport equipment for $1.5 million.

The required rate of return for the project is 12% per annum.

(a) If the price of copper was below the benchmark rate in the first year of the contract, would you advise Coleman Ltd to exercise their option to walk away from the project at the end of the first year? (Show your work. Your answer must be handwritten)

(b) What is the total value of the contract to Coleman Ltd today? (Show your work. Your answer must be handwritten)

Question 5 (10 marks)

Diacono Ltd, is the largest listed shoe manufacturing company in Australia and is         considering launching a bid for Midgley Ltd, it’s chief competitor. You are engaged by Diacono Ltd to consider the merits of the proposed deal and collect the following pre- bid information regarding the two companies.

You also estimate that if the deal was to go through then the following events would be expected to occur:

•   There would be one-off integration costs of $2 million at the end of each of the first two years post-acquisition associated with bringing the two businesses      together

•   The ability to sell extra shoes to each other’s customers would increase net sales revenues (after tax) by $5 million per annum (at year end) for the next 7 years

•   The elimination of identical roles across the two organisations would reduce net costs (after tax) by $3 million per annum over the next 4 years

(a) Assuming that the appropriate discount rate for the evaluation is 11% per annum    (after-tax), what is the present value of the gain from the acquisition? (Show your work. Your answer must be handwritten)

(b) What takeover premium (measured as a percentage of current share price) would Diacono Ltd have to offer Midgley Ltd shareholders in order to split the gain equally between the two shareholder groups? (Show your work. Your answer must be           handwritten)

Question 6 (10 marks)

Tasty Pies is expanding its business and wants to open a new facility to make frozen      pies, which requires a new automated pie maker. One such pie maker can be purchased for $300,000. Alternatively, it can be leased for $52,000 per year for seven years and      lease rentals need to be paid annually in advance. The management informs you that    the new pie maker can be fully depreciated to zero using the straight-line method over four years and that its scrap/residual value is expected to be $5,000 at the end of the     lease. Tasty Pies has estimated that the appropriate after-tax opportunity cost of capital of the expansion is 19% per annum, and the net present value of the expansion is          expected to $10,000.

Tasty Pies pays tax at the rate of 30% and it can borrow funds at a before-tax rate of    11% per annum. All cash-flows have been quoted on a before-tax basis. Would you     recommend that Tasty Pies buy or lease the pie maker? What is the incremental wealth associated with your decision? (Show your work. Your answer must be handwritten)

Question 7 (10 marks)

ABC Inc is a publicly listed company in Australia and pays corporate tax rate at a rate of 30%. The company conducted its first off-market share buyback on April 15, 2015 and  the shareholders were invited to tender their shares between $3.40 and $4.20. ABC’s     volume weighted average price over the five days before the announcement was $3.98 and over the period from the announcement to the close of the buyback the market     index decreased by 0.8%. ABC announced the buyback price to be $3.40 with capital     component of $0.95 and the rest will be treated a fully franked dividend. The buyback  was conducted under tax determination TD 2004/22.

John Major, who is a resident Australian investor, bought 200 shares in ABC at $1.25 per share on July 15, 2014 and sold all his shares in the buyback. You need to answer the     following questions with regards to the buyback:

(a) What was the per share capital gain or loss under the buyback for John Major? (Show your work. Your answer must be handwritten)

(b) Assume that John’s personal tax rate is 20%. What were the total after-tax proceeds that he received after selling all his shares in the buyback? (Show your work. Your         answer must be handwritten)

Question 8 (10 marks)

Fish Pies Inc. (FPI) has recently announced its intention to acquire Hamburgers ‘R Us       (HRU). FPI has identified potential annual gains from the acquisition of $250,000 per       annum forever, with the first cash flow occurring exactly four years after the acquisition.  If the acquisition were to proceed, FPI will however incur re-organization and integration costs of $300,000 per annum at the end of the first two years after the acquisition.          Information about the two companies’ relevant share prices and shares outstanding is    provided below:

FPI has also decided to make a cash bid for all outstanding shares of HRU and offers      $6.40 per share to HRU shareholders. The appropriate opportunity cost of capital is 12% per annum

(a) Assuming the acquisition occurred immediately, calculate the gain from the acquisition. (Show your work. Your answer must be handwritten)

(b) Assuming the acquisition occurred immediately, calculate the total wealth impact for shareholders of Hamburgers ‘R Us. (Show your work. Your answer must be handwritten)

Question 9 (10 marks)

Acme is expected to sell 500,000 units of its product in year 1. From year 2 to year 5,      Acme’s sales volume (in units) is expected to increase by 10% each year. After year 5,     Acme’s sales volume is expected to increase by 1% in perpetuity. The selling price per    unit is expected to be $10 in year 1 and Acme is expected to increase the selling price    by 1% each year thereafter. Acme’s EBIT margin is expected to be 40% of (dollar) sales   for the next 4 years and 30% thereafter. Acme’s depreciation expense is expected to be  20% of sales for the next two years and 10% thereafter. Acme’s capital expenditures are expected to be 25% sales for the next three years and 10% thereafter. Acme’s net           working capital is $450,000 today and is always expected to be 10% of sales in future     years. (Note that this is the net working capital, not the change in net working capital.)   Acme’s shares are trading at $10 per share and Acme has 2,000,000 shares outstanding. The market value of Acme’s debt is $5,000,000. Acme’s after-tax cost of debt is 4%, the  risk-free rate is 1%, the market risk premium is 12%, and the unlevered beta for              comparable firms is 1.2. The corporate tax rate is 35%. Assume all cash flows occur at     the end of the year. Using the DCF model, are Acme’s shares undervalued or                   overvalued? Based on the DCF, what is the fair value for Acme shares? Answer based      only on the information provided. (Show your work in Excel. Copy-paste your Excel work to your answer document using ‘Paste as Picture’)