Finance Exam 4 Study Guide

Outstanding debt of Home Depot trades with a yield to maturity of 8%. The tax rate of Home Depot is 30%. What is the effective cost of debt of Home Depot?

0.08 * (1 - 0.3) = 0.056

A company issues a callable (at par) ten-year, 6% coupon bond with annual coupon payments. The bond can be called at par in one year after release or any time after that on a coupon payment date. On release, it has a price of $104 per $100 of face value. What is the yield to maturity of this bond when it is released?

1.92%

A bond has a face value of $10,000 and a conversion ratio of 530. The stock is currently trading at $16.50. What is the conversion price?

10,000 / 530 = $18.87

A firm issues $170 million in straight bonds at par and a coupon rate of 8.5%. The firm pays fees of 2% on the face value of the bonds. The net amount of funds that the debt issue will provide for the firm is ________.

170 mil * (1 - 0.02) = 167 mil

Valiant Industries has 30 million shares of stock outstanding at a price of $28 per share. The company wishes to raise more money and plans to do so through a rights issue. Every existing stockholder will receive one right for each share of stock held. For every four rights held by the stockholder, they can buy one share at a price of $28. If all rights are exercised, how much money will be raised in this offer?

28 * 30 mil / 4 = $210 mil

Assume preferred stock of Ford Motors pays a dividend of $4 each year and trades at a price of $35. What is the cost of preferred stock capital for Ford?

4 / 35 = 0.114

A company issues a callable (at par) five-year, 7% coupon bond with annual coupon payments. The bond can be called at par in one year after release or any time after that on a coupon payment date. On release, it has a price of $110 per $100 of face value. What is the yield to call of this bond when it is released?

5.66%

A firm issues $500 million in straight bonds at par and a coupon rate of 5%. The firm pays fees of 2% on the face value of the bonds. What is the net amount of funds that the debt issue will provide for the firm?

500 * (1 - 0.02) = 490 mil

Convex Incorporated sells 10 million shares of stock in an SEO—8 million being primary shares issued by the company and 2 million being secondary shares sold by investors in the company. At the time of the sale, Convex's stock was selling at $7.50 per share. If the underwriter charges 4% of the gross proceeds as a fee, how much money was raised in the sale?

7.5 * 96% * 8 mil = 57.6 mil

A firm has a capital structure with $75 million in equity and $45 million of debt. The cost of equity capital is 10% and the pretax cost of debt is 7%. If the marginal tax rate of the firm is 40%, compute the weighted average cost of capital of the firm.

= [75 / (75+45)] * 0.1 + 0.07 *(1 - 0.4) * 45 / (75 + 45) = 7.8%

A firm incurs $35,000 in interest expenses each year. If the tax rate of the firm is 30%, what is the effective after-tax interest rate expense for the firm?

Effective after-tax interest expense = interest expense * (1-tax rate) 35,000 * (1-0.3) = $24,500

Assume the total market value of General Motors (GM) is $10 billion. GM has a market value of $6 billion of equity and a face value of $12 billion of debt. What are the weights in equity and debt that are used for calculating the WACC?

Equity = 6 mil / 10 mil = 0.60; Debt = (10 mil - 6 mil) / 10 mil = 0.40

Assume General Motors has a weighted average cost of capital of 9%. GM is considering investing in a new plant that will save the company $20 million over each of the first two years, and then $10 million each year thereafter. If the investment is $100 million, what is the net present value (NPV) of the project?

NPV = -100 mil + 20 mil / (1.09) + (20 mil + 111.111111 mil) / (1.09) * 2 = 28.7 mil

Jeremy founded a company. He issues 100,000 shares of series A stock for his own $100,000 investment. He then goes through three further rounds of investment, as shown below: Series B $1.00 500,000 Series C $1.50 300,000 Series D $1.75 500,000 What is the post-money valuation for the series D funding round?

Total = 500,000 + 300,000 + 500,000 + 100,000 = 1.4 mil; Post-money valuation = $1.75 * 1.4 mil = $2.45 mil

You founded your own firm three years ago. You initially contributed $200,000 of your own money and in return you received 3 million shares of stock. Since then, you have sold an additional 2 million shares of stock to angel investors. You are now considering raising capital from a venture capital firm. This venture capital firm would invest $4 million and would receive 2 million newly issued shares in return. Assuming that this is the venture capitalist's first investment in your firm, what percentage of the firm will the venture capitalist own?

Total Outstanding = 3 mil + 2 mil + 2 mil = 7 mil Venture capitalist ownership % = 2 mil / 7 mil = 29%

Simone founded her company using $200,000 of her own money, issuing herself 200,000 shares of stock. An angel investor bought an additional 100,000 shares for $150,000. She now sells another 500,000 shares of stock to a venture capitalist for $1.5 million. What is the post-money valuation of the company?

Total shares = 500,000 + 200,000 + 100,000 = 0.8 mil

Epiphany is an all-equity firm with an estimated market value of $300,000. The firm sells $250,000 of debt and uses the proceeds to purchase outstanding equity. Compute the weight in equity and the weight in debt after the proposed financing and repurchase of equity.

Weight in debt = debt raised / market value of firm; Weight in equity = 1 - weight in debt WiD = 250,000 / 300,000 = 0.83 WiE = 1 - 0.83 = 0.17

A firm has outstanding debt with a coupon rate of 8%, nine years maturity, and a price of $1,000. What is the after-tax cost of debt if the marginal tax rate of the firm is 40%?

YTM = coupon rate After-tax cost = coupon rate * (1 - tax rate) + 0.08 * (1- 0.4) = 4.8%

Which of the following best describes an international bond that is not denominated in the local currency of the country in which it is issued?

a Eurobond

A large publishing firm specializing in college textbooks wishes to expand into online delivery of its materials. In order to facilitate this, it invests in a number of small start-up companies that deliver college courses online and uses these companies to start diversifying the delivery of its content. Which of the following best describes the role of the publishing firm as described above?

a corporate investor

In terms of public offerings of bonds, what is a prospectus?

a formal contract that specifies a firm's obligations to the bondholders

Athelstone Realty issues debt with a maturity of 20 years. In the case of bankruptcy, holders of this debt may claim the property held by Athelstone Realty. Which of the following best describes this type of corporate debt?

a mortgage bond

The relative proportion of debt, equity, and other securities that has a firm has outstanding constitute its __________.

capital structure

A levered firm is one that has __________ outstanding.

debt

A callable bond will typically have a ________ yield than an otherwise identical bond without a call feature because ________.

higher, the option to call a bond is valuable

Assume Ford Motor Company is discussing new ways to recapitalize the firm and raise additional capital. Its current capital structure has a 25% weight in equity, 10% in preferred stock, and 65% in debt. The cost of equity capital is 13%, the cost of preferred stock is 9%, and the pretax cost of debt is 8%. What is the weighted average cost of capital for Ford if its marginal tax rate is 40%?

rwacc = 0.25 * 0.13 + 0.65 * 0.08 * (1 - 0.4) + 0.1 * 0.09 = 0.0727

The offer price of shares in an IPO is generally less than the price those shares sell for at the end of the first trading day. Which of the following parties suffer most from this situation?

the buyers of shares after the initial offering

Many financial managers use market risk premiums that are closer to 5%, which is lower than historical averages, because ________.

the return investors require as compensation for taking of investing in equity markets has diminished over a period of time

The outstanding debt of Berstin Corp. has ten years to maturity, a current yield of 7%, and a price of $95. What is the pretax cost of debt if the tax rate is 30%.

Current yield = coupon / price; 0.07 = coupon / 95; so coupon = 6.65; Yield to maturity = pretax cost of debt; use financial calculator for rest

A company issues a 10-year, callable bond at par with 8% annual coupon payments. The bond can be called at par in one year after issue or any time after that on a coupon payment date. The call price is $104 per $100 of face value. What is the yield to call if this bond is called in one year?

Compute I / Y = 12%

SIROM Scientific Solutions has $5 million of outstanding equity and $5 million of bank debt. The bank debt costs 4% per year. The estimated equity beta is 2. If the market risk premium is 8% and the risk-free rate is 4%, compute the weighted average cost of capital if the firm's tax rate is 35%.

Cost of debt = rate on bank debtCost of equity = Risk-free rate + Beta × Market risk premiumWeight of equity = Outstanding equity / (Outstanding equity + Debt)Weight of debt = 1- Weight of equity.LaTeX:rwacc=rEE%+rD(1−Tc)D%Cost of equity = 0.04 + 2 × 0.08 = 0.2 or 20%Weight of equity = 5/(5 + 5) = 0.5 or 50%Weight of debt = 1 - 0.5 = 0.5 or 50%WACC = 0.5 x 0.2 + 0.5 x 0.04 x (1-0.35) = 11.30%

Assume Time Warner shares have a market capitalization of $60 billion. The company is expected to pay a dividend of $0.30 per share and each share trades for $40. The growth rate in dividends is expected to be 7% per year. Also, Time Warner has $20 billion of debt that trades with a yield to maturity of 8%. If the firm's tax rate is 35%, compute the WACC?

Cost of equity = (.30 / 40) + 0.07 = 0.0775; Cost of debt = 0.08 * (1 - 0.35) = 0.052; WACC = (60 mil * 0.0775) / 80 bil + (20 bil * 0.052) / 80 bil = 0.0711

IBM expects to pay a dividend of $2 next year and expects these dividends to grow at 9% a year. The price of IBM is $80 per share. What is IBM's cost of equity capital?

Cost of equity = (Div1 / PE) + g = (2 / 80) + 0.09 = 0.1150

Your estimate of the market risk premium is 6%. The risk-free rate of return is 4% and General Motors has a beta of 1.4. What is General Motors' cost of equity capital?

Cost of equity = 0.04 + (1.4 * 0.06) = 0.124

An all-equity firm had a dividend expense of $20,000 last year. The market value of the firm is $600,000 and the dividend is expected to increase at 5% each year. What is the cost of equity for this firm?

Cost of equity = dividend / current price + dividend growth rate = (20,000 * (1 + 0.05) / 600,000) + 0.05 = 8.5%

A firm has $2 million market value and it sells preferred stock with a par value of $100. If the coupon rate on the preferred stock is 6% and the preferred stock trades at $98, what is the cost of preferred stock capital?

Cost of preferred stock capital = preferred dividend / preferred stock price = (6% * 100) / 98 = 6.12

Price ($) Number of Shares Bid 6.00 100,000 6.25 200,000 6.50 450,000 6.75 150,000 7.00 450,000 7.25 100,000 7.50 300,000 Harrison Products is selling 1 million shares of stock in an auction IPO. At the end of the bidding period it has received the bids shown above. Which of the following is closest to the price at which the shares will be offered?

Cumulative shares = 300,000 + 100,000 + 450,000 + 150,000 = 1 mil so, $6.75

Assume Ford Motors expects a new hybrid-engine project to produce incremental cash flows of $45 million each year, and expects these to grow at 3% each year. The upfront project costs are $380 million and Ford's weighted average cost of capital is 9%. If the issuance costs for external finances are $10 million, what is the net present value (NPV) of the project?

PV project cash inflows = 45 mil / (0.09 - 0.03) = 750 mil; cash outflows = 380 mil + 10 mil = 390 mil; NPV = 750 mil - 390 mil = 360 mil