corporate finance final exam MC
Which of the following lists events in the chronological order from earliest to latest?
declaration date, ex-dividend date, record date, payment date
assets are listed on the balance sheet in order of
decreasing liquidity
retained earnings are
difference between net income earned and dividends payed out during the year
the following are sensible motives for mergers except
diversification
Firms can pay out cash to their shareholders in the following ways:
dividends share repurchases
The constant dividend growth formula P0 = Div1/(r - g) assumes:
dividends are growing at a constant rate (g) forever r>g
If both dividends and capital gains are taxed at the same ordinary income tax rate, the effect of tax is different because:
dividends are taxed when distributed while capital gains are deferred until the stock is sold
which of the following stocks is an income stock
dow chemicals
the positive value to the firm by adding debt to the capital structure in the presence of corporate taxes is:
due to the extra cash flow going to investors of the firm rather than tax authorities
The following are important motives for privatization except:
economies of scale
the cost of capital is the same as the cost of equity for firms that are financed
entirely by equity
US dollars deposited in a German bank are called:
eurodollars
Money that a firm has already spent, or committed to spend regardless of whether a project is taken, is called:
sunk cost
An example of a shark-repellent charter amendment is:
supermajority waiting period poison pill staggered board
The following are good reasons for mergers:
surplus funds complementary resources eliminating inefficiencies
The par value of the outstanding shares is defined as:
legal capital
Which of the following investors have the strongest tax reason to prefer dividends over capital gains?
corporations
the payback period rule accepts all projects for which the payback period is
less than the cut-off value
using the company cost of capital to evaluate a project is:
correct for projects that have average risk compared to firms other assets
what percentage of corporate financing is made up of internal funds for firms in the US
75%
the survey of CFOs indicates that NPV method is always or almost always, used for evaluating investment projects
75% of firms
(Approximately) Corporate tax rate: 34% Personal tax rate on income from bonds: 30% Personal tax rate on income from stocks: 20%
$0.25 [1 - ((1 - Tc)(1 - TpE)/(1 - Tp))]D = [1 - ((0.66)(1 - 0.2)/(1 0.3)]D = 0.25D; $0.25
If a firm borrows $50 million for one year at an interest rate of 10%, what is the present value of the interest tax shield? Assume a 30% tax rate. (Approximately.)
$1.364 million PV of interest tax shield = ((0.3)(50)(0.1))/1.1 = $1.364
he New Word Corporation has 1,000,000 shares outstanding at $30/share. If the firm wishes to raise $13.5 million at a subscription price of $27/share, calculate the value of a right.
$1/right # of new shares = 13,500,000/27 = 500,000 shares; # rights required to buy a new share = 1,000,000/500,000 = 2 rights; value of a right = (30 - 27)/(2 + 1) = $1/right
Image Storage Corporation has #1,000,000 shares outstanding. It wishes to issue 500,000 new shares using rights issue. If the current stock price is $50 and the subscription price is $47/share, calculate the value of a right?
$1/share Value of a right = (50 - 47)/(2 + 1) = $1.00/right
If the old stock price is $50/share and ex-rights price is $49/share then the value of a right is:
$1/share Value of a right = 50 - 49 = $1/right
Two corporations A and B have exactly the same risk and both have a current stock price of $100. Corporation A pays no dividend and will have a price of $120 one year from now. Corporation B pays dividends and will have price of $113 one year from now after paying the dividend. The corporations pay no taxes and investors pay no taxes on capital gains but pay a tax of 30% income tax on dividends. What is the value of the dividend that investors expect corporation B to pay one year from today?
$10 Dividend = (120 - 113)/0.7 = $10
Given the following data for year-1: Profits after taxes = $20 M Depreciation = $6 M Interest expense = $4 M Investment in fixed assets = $12 M Investment in working capital = $4 M Calculate the free cash flow (FCF) for year-1:
$10 M FCF = 20 + 6 - 12 - 4 = 10
A project requires an initial investment of $200,000 and is expected to produce a cash flow before taxes of 120,000 per year for two years. [i.e. cash flows will occur at t = 1 and t = 2]. The corporate tax rate is 30%. The assets will be depreciated using MACRS - 3 year schedule: (t=1, 33%); (t = 2: 45%); (t = 3: 15%); (t = 4: 7%). The company's tax situation is such that it can make use of all applicable tax shields. The opportunity cost of capital is 12%. Assume that the asset can be sold for book value. Calculate the NPV of the project (Approximately)
$16,244 -200,000 + (103,800/1.12) + ((111,000 + 44,000)/(1.12^2)) = $16,244
You have been asked to evaluate a project with infinite life. Sales and costs are projected to be $1000 and $500 respectively. There is no depreciation and the tax rate is 30%. The real required rate of return is 10%. The inflation rate is 4% and is expected to be 4% forever. Sales and costs will increase at the rate of inflation. If the project costs $3000, what is the NPV?
$365.38 NPV = [((1000/1.04) - (500/1.04)) (0.7)] / 0.1 - (3000 ) = $365.38
Assume GE has about 10.3 billion shares outstanding and the stock price is $37.10. Also assume the PE ratio is 18.3. calculate market capitalization for GE.
$382 billion market capitalization = (10.3)(37.10) = 382.1
Suppose that the merger really does increase the value of the combined firms by $20,000 (i.e., PVAB - PVA - PVB = $20,000). What is the cost of the merger? Companies A and B are valued as follows: A # shares = 2000 EPS = $10 share price = $100 B # shares = 1000 EPS = $10 share price = $50
$4,000 PVAB = 200,000 + 50,000 + 20,000 = 270,000; Price per share = 270,000/2,500 = 108; Cost = (108)(500) - 50,000 = 4,000
wealth and health company is financed entirely by common stock priced to offer a 15% expected return. the common stock price is $40/share. The EPS is expected to be $6. if the company repurchases 25% of the common stock and substitutes an equal value of debt yielding 6%, what is the expected EPS after refinancing?
$7.20 I = (10)(0.06) = 0.60; new EPS = (6-0.60)/0.75 = $7.20/share
Given the following data: FCF1 = $7 M FCF2 = $45 M FCF3 = $55 M free cash flow grows at a rate of 4% for year 4 and beyond. If the weighted average cost of capital is 10%, calculate the value of the firm.
$801.12 M Horizon value in year-3 = (55)(1.04)/(0.1 - 0.04) = $953.33 million PV = (7/1.1) + (45/1.1^2) + [(55 + 953.33)/(1.1^3)] = $801.12 million
A firm has issued $5 par value preferred stock that pays a $0.80 annual dividend. The stock currently sells for $9.50. In calculating a WACC, what would be the value of the firm's preferred stock?
$9.50 market value of the stock is all that matters
Company X has 100 shares outstanding. It earns $1,000 per year and expects to pay all of it as dividends. If the firm expects to maintain this dividend forever, Calculate the stock price after the dividend payment. (The required rate of return is 10%)
$90 stock price - div payment = 100 - 10 = 90
For every dollar of operating income paid out as interest, the bondholder realizes:
(1 - Tp)
For every dollar of operating income paid out as equity income, the shareholder realizes:
(1 - TpE)(1 - Tc)
When faced with financial distress; managers of firms acting on behalf of their shareholders' interests will:
- favor high risk, high return projects even if the have negative NPVs - refuse to invest in low risk, low return projects even if they have positive NPVs - delay onset of bankruptcy as long as they can - favor issuing large quantity of low quality debt to low quantity of high quality debt - favor paying high dividends to shareholders
Project M requires an initial investment of $25 millions. The project is expected to generate $2.25 millions in after-tax cash flows each year forever. Calculate the IRR for the project.
-25 + 2.25/IRR = 0 IRR = 25/2.25 = 9%
What is the profitability index of an investment with cash flows in years zero thru 4 of -340, 120, 130, 153, and 166, respectively and a discount rate of 16%?
0.15 NPV = 49.7 PI = 49.7/340 = .15
MM proposition 1 with corporate taxes states that
1) capital structure can affect the value of a firm by an amount equal to the PV of tax shield 2) by raising debt-to-equity ratio, the firm can lower its taxes and thereby increase its total value 3) firm value is maximized at an all debt capital structure
Financial practitioners include short-term debt in WACC calculations:
1) if short-term debt is at least 10% of the short term liabilities 2) if net working capital is negative
Free cash flow (FCF) and net income (NI) differ in the following ways:
1) net income is the return to shareholders, calculated after interest expense; FCF is calculated before interest 2) net income is calculated after various non-cash expenses, including depreciation; FCF adds back depreciation 3) capex and investments in WC do not appear in net income calculations; they do reduce FCF
Which of the following factors influence the choice between merger and an acquisition of stock?
1) shareholders are dealt with directly to bypass target management and board of directors 2) in a tender offer, usually some minority shareholders do not tender stopping complete firm absorption 3) target management might be unfriendly and resist the offer which in turn would raise stock price
he Flow-to-equity method:
1) uses cash flows to equity, after interest and after taxes 2) uses cost of equity capital as the discount rate
If you own 1,000 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?
1,000
Arrange the following in the chronological order for a startup firm:
1. VC financing 2. stages 1,2,3,4 ... 3. mezzanine financing 4. IPO
A cash flow received in two years is expected to be $10,816 in nominal terms. If the real rate of interest is 2% and the inflation rate is 4%, what is the real cash flow for year-2?
10,000 Real cash flow = 10,816/(1.04^2) = 10,000
If the corporate tax rate is 35%, what is the maximum effective tax rate on dividends received by another corporation?
10.5% 70% of dividends received by another corporation is tax-exempt. Tax rate = (0.3) * (0.35) = 0.105 = 10.5%
A corporation has 1,000,000 shares outstanding and 10 directors are up for election. If the stock features cumulative voting, approximately how many shares do you have to muster in order to guarantee yourself a place on the board of directors? (Ignore possible ties)
100,000 # shares = 1,000,000/10 = 100,000
What will be the post-merger price per share for Firm A's stock if Firm A pays in cash? Firm A price per share = $100 total earnings = $500 shares outstanding = 100 total value = $10,000 Firm B price per share = $10 total earnings = $300 shares outstanding = 40 total value = $400
102 P = (10,000+200)/100 = 102
Seven-Seas Co. has paid a dividend $3 per share out of earnings of $5 per share. If the book value per share is $40 and the market price is 52.50 per share, calculate the required rate of return on the stock
11% g = (1 - 0.6) (5/40) = .05 or 5%; r = [(3 * 1.05)/52.50] + 0.05 = 0.11 = 11%.
The equity accounts of Bio-Tech Company is as follows: common shares ($1 par value) = $10,000,000 Suppose the firm sells 2,000,000 new (additional) shares at a price of $20 per share. What is the new value of Common Shares account?
12,000,000 common shares = 10,000,000 + 2,000,000 = 12,000,000
A firm has a debt-to-equity ratio of 1. Its cost of equity is 16%, and its cost of debt is 8%. If the corporate tax rate is 25%, what would its cost of equity be if the debt-to-equity-ratio were 0?
12.57%
The In-Tech Co. has just paid a dividend of $1 per share. The dividends are expected to grow at 25% per year for the next three years and at the rate of 5% per year thereafter. If the required rate of return on the stock is 18%(APR), what is the current value of the stock?
12.97 P = (1.25/1.18) + (1.5625/1.18^2) + (1.9531/1.18^3) +(2.0508/((1.18^3) * (0.18 - 0.05)) = 12.97
The Marble Paving Co. has an equity cost of capital of 17%. The debt to equity ratio is 1.5 and a cost of debt is 11%. What is the cost of equity if the firm was unlevered? (Assume a tax rate of 33%)
14.0% 0.17 = r + (1.5)(0.67)(r - 0.11); r = 14%
Firm A has a value of $100 million, and B has a value of $70 million. Merging the two would allow a cost savings with a present value of $20 million. Firm A purchases B for $75 million. How much do firm A's shareholders gain from this merger?
15 million NPV = (190 + 75) - 100
According "Venture Economics" venture capital funds earn an average annual rate of return of:
17%
in the US the premium that an investor needed to pay to gain voting control is
2%
The Granite Paving Co. wishes to have debt-to-equity ratio of 1.5. Currently it is an unlevered (all equity) firm with a beta of 1.1. What will be the beta of the firm if it goes through the capital restructuring process and attains the target debt-to-equity ratio? Assume a tax rate of 30%
2.26 bl = bo [1 + (D/E) (1 - Tc)] = 1.1 [1 + (1.5)(0.7)] = 2.26
The gain from the merger is $600. Firm A pays $20 for each share of B. Calculate the NPV of the merger. Firm A price per share = $100 total earnings = $500 shares outstanding = 100 total value = $10,000 Firm B price per share = $10 total earnings = $300 shares outstanding = 40 total value = $400
200 NPV = Gain - cost NPV = (11,000-10,400) - (20(40) - 400) = 200
Venture capital investment was highest in the year:
2000
In order to find the present value of the tax shields provided by debt, the discount rate used is the:
cost of debt
Summer Co. is expected to pay a dividend or $4.00 per share out of earnings of $7.50 per share. If the required rate of return on the stock is 15% and dividends are growing at a current rate of 10% per year, calculate the present value of the growth opportunity for the stock (PVGO)
30 No growth value = 7.5/0.15 = 50; Po = 4/(0.15 - 0.1) = 80; PVGO = 80 - 50 = 30
If a firm permanently borrows $100 million at an interest rate of 8%, what is the present value of the interest tax shield? (Assume that the tax rate is 30%)
30 million PV of interest tax shield = (0.3)(100) = $30 million
The PEN Corporation with a book value of $20 million and a market value of $30 million has merged with the CNC Corporation with a book value of $6 million and a market value of $8 million at a price of $9 million. If the transaction is a purchase then the total assets on the books of the new company will be
39 million Purchase method: 30 + 8 + 1 = 39
Michigan Co. is currently paying a dividend of $2.00 per share. The dividends are expected to grow at 20% per year for the next four years and then grow 6% per year thereafter. Calculate the expected dividend in year 5.
4.40 DIV6 = 2 (1.2^4) (1.06)
A firm has $100 million in current liabilities, $200 million in total long-term liabilities and $300 million in stockholders' equity, total assets of $600 million. Calculate the long-term debt ratio for the firm.
40% long-term debt ratio = (200)/(200 + 300) = .4
A firm has a general-purpose machine, which has a book value of $300,000 and is sold for $500,000 in the market. If the tax rate is 35%, what is the opportunity cost of using the machine in a project?
430,000 500,000 - (500,000 - 300,000) * 0.35 = 430,000
Firm A has a value of $100 million, and B has a value of $70 million. Merging the two would allow a cost savings with a present value of $20 million. Firm A purchases B for $75 million. What is the cost of this merger?
5 million 75 - 70 = 5
If you own 1,000 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 cumulative voting?
5,000 total number of votes = 5 x 1,000
A firm has $100 million in current liabilities, $200 million in total long-term liabilities and $300 million in stockholders' equity, total assets of $600 million. Calculate the debt ratio for the firm.
50% debt ratio = (100 + 200)/600 = .5
A project requires an investment of $900 today. It has sales of $1,100 per year forever. Costs will be $600 the first year and increase by 20% per year. Ignoring taxes calculate the NPV of the project at 12% discount rate.
57.51 NPV = -900 + (1,100 - 600)/1.12 + (1,100 - (600*1.2))/(1.12^2) + (1,100 - 600 (1.2^2))/(1.12)^3 + (1,100 - 600 (1.2^3))/(1.12^4) = $57.51. (The project is stopped when costs> revenues)
In 1988 LBOs were on average financed with 90% debt. In recent years the figure is:
60%
Ocean Co. has paid a dividend $2 per share out of earnings of $4 per share. If the book value per share is $25, what is the expected growth rate in dividends (g)?
8% g = 0.50 (4/25) = 8%
Company A now acquires B by offering one (new) share of A for every two shares of B (that is, after the merger, there are 2500 shares of A outstanding). If investors are aware that there are no economic gains from the merger, what is the price-earnings ratio of A's stock after the merger? Companies A and B are valued as follows: A # shares = 2000 EPS = $10 share price = $100 B # shares = 1000 EPS = $10 share price = $50
8.33 EPS = [2000(10) + 1000(10)]/2500 = 12 PPS = [2000(100) + 1000(50)]/2500 = 100 P/E = 100/12 = 8.33
The equity accounts of Bio-Tech Company is as follows: common shares ($1 par value) = $10,000,000 additional paid-in-capital = $50,000,000 (in excess of par) Suppose that the firm sells 2,000,000 new shares at a price of $20/share. What is the new value of the additional paid-in-capital account?
88,000,000 Additional paid-in-capital = (2,000,000)(19) = 38,000,000; new additional paid-in-capital account = 50,000,000 + 38,000,000 = 88,000,000
A firm has zero debt in its capital structure. Its overall cost of capital is 8%. The firm is considering a new capital structure with 50% debt. The interest rate on the debt would be 5%. Assuming that the corporate tax rate is 40%, its cost of equity capital with the new capital structure would be?
9.8% rE = 8 + (1 - 0.4)(1)(8 - 5) = 8 + 1.8 = 9.8%
Company X has 100 shares outstanding. It earns $1,000 per year and expects repurchase its shares in the open market instead of paying dividends. Calculate the number of shares outstanding at the end of year-1, if the required rate of return is 10%
90 Share price before repurchase = [1000/100]/0.1 = 100 Instead of paying dividends they can repurchase 10 shares
Sarbanes-Oxley Act
A law passed by Congress that requires the CEO and CFO to certify that their firm's financial statements are accurate.
the BP and Amoco merger is an example of
cross-border merger, horizontal merger, economies of scale
Floatation costs are incorporated into the APV framework by:
subtracting them from all equity value of the project
The following mergers have been blocked on antitrust grounds except:
AOL and Time Warner
The following are examples of LBOs except
America Online and Time Warner Benz and Chrysler
for a levered firm,
As EBIT increases, EPS increases by a larger percentage
If you own 1,000 shares of stock and you can cast 5,000 votes for a particular director, then the stock features:
cumulative voting
Suppose a government wishes to auction 5 million bonds and three would-be buyers submit bids: Buyer A = $1,015 Buyer B = $1,000 Buyer C = $990 in a uniform-price auction:
Buyer A and Buyer B pay 1,000
Suppose a government wishes to auction 5 million bonds and three would-be buyers submit bids: Buyer A = $1,015 Buyer B = $1,000 Buyer C = $990 in a discriminatory auction:
Buyer A pays 1,015 and Buyer B pays 1,000
The average initial returns from investing in IPOs is the highest in:
China
the following are characteristics of preferred stock EXCEPT
voting rights
If firms A is acquiring firm B and Bs shareholders are given the fraction x of the combined firm, then the cost of this merger is:
Cost = (x)(PVAB) - PVB
IRR method is also called
DCF rate of return method
Which of the following formulas regarding earnings to price ratio is true:
EPS/Po = r[1 - (PVGO/Po)]
What are some of the possible consequences of financial distress?
Equity investors would like the firm to shift toward riskier lines of business.
On January 2, Michigan Mining declared a $25-per-share quarterly dividend payable on March 9th to stockholders of record on February 9. What is the latest date by which you could purchase the stock and still get the recently declared dividend?
February 6th
Firm A is planning to acquire Firm B. If Firm A prefers to make a cash offer for the merger it indicates that:
Firm A's managers are optimistic about the post merger value of A
On the average, firms (manufacturing industry) of the following countries have lower levels of debt ratio (after adjusting for accounting differences) except:
Italy IT = high debt ratio
Which of the following is not a major item of US antitrust legislation?
Garn-St. Germain Act
On the average, firms (manufacturing sector) of the following countries have about AVERAGE levels of DEBT ratio (after adjusting for accounting differences) EXCEPT:
Germany
A general cash offer involves the following processes:
I) register the issue with the SEC II) sell the securities to an underwriter or a syndicate of underwriters III) underwriter builds up a book of likely demand for the securities IV) price of the issue is fixed V) sell the securities to the public
private-equity partnerships can cash out of companies in the partnership's portfolio in the following ways:
IPO or trade sale
an underwriters spread is highest for
IPOs
the following are some of the shortcomings for the IRR method except
IRR is conceptually hard to communicate
The main difference in a tax-free versus taxable acquisition to the shareholders is that:
In a tax-free acquisition shares are only exchanged, while in a taxable transaction the shares are considered sold and realized capital gains or losses are taxed
The flow to equity method provides an accurate estimate of the value of a firm if:
debt-equity ratio remains constant for the life of the firm
in which of the following a computer acts as the auctioneer
London stock exchange, tokyo stock exchange, frankfurt stock exchange
Two machines, A and B, which perform the same functions, have the following costs and lives. machine A: PV(costs) = 6000 life = 5 yrs machine B: PV(costs) = 8000 life = 7 years Which machine would you choose? The two machines are mutually exclusive and the cost of capital is 15%.
Machine A as the EAC is $1789.89 EAC(A) = 6,000/3.35215 = 1789.89 EAC(B) = 8000/4.1604 = 1922.88
The premium paid by investors to gain voting control, among the countries mentioned, is the highest in:
Mexico
If a bond is junior or subordinated, it
Must give preference to senior creditors in the event of default
which of the following investment rules has value adding up property
NPV method
in which of the following stock exchange specialists act as the auctioneers
NYSE
the following is an example of a dealers market
Nasdaq
the stock exchange that specializes in trading the shares of young and rapidly growing companies is
Nasdaq
On the average, firms of the following countries have higher levels of debt ratios (after adjusting for accounting differences) except
Netherlands NL = low debt ratio
The acquisition of stock has the advantage of:
No shareholder meeting to vote is necessary
Real cash flow occurring in year-2 is $60,000. If the inflation rate is 5% per year, the real rate of interest is 2%, calculate the cash flow for the year-2.
Nominal cash flow = (60,000)(1.05)^2 = 66,150
The following are examples of LBOs that reverted to being public companies
Northwest Airlines Safeway Kaiser Aluminium
The following are examples of carve-outs:
Northwest airlines and Pinnacle Airlines Sara Lee and Coach Union Pacific and Overnite Corp
information effect
Outcome in which relevant information is spread by firms or individuals to other members of the social network
benefit-cost ratio is defined as the ratio of
PV of cash flow to initial investment
a high proportion of the value of a growth stock comes from
PVGO
Following an acquisition, the acquiring firm's balance sheet shows an asset labeled "goodwill." What form of merger accounting is being used?
Purchase
the exchange traded fund that tracks the NASDAQ 100 index is called
QQQQ
Which of the following investments allows investors to own assets indirectly via shares that are part of a pool of other investors?
RIET Trust
Flow-based insolvency occurs when:
current obligations are greater than operating cash flows assets minus liabilities is less than 0 there is no cash for dividend payments
the payback period rule
Requires an arbitrary choice of a cut-off point.
the SEC provision under which qualified institutional investors can trade privately placed securities among themselves is called
Rule 144A
registration statements are filed with the
SEC
What are the tax consequences of a taxable merger?
Selling shareholders must recognize any taxable gain
Which of the following statements regarding spin-offs and carve-outs is not true?
Spin-offs are not taxed if the shareholders of the parent company are given a majority of shares in the new company
the value of a common stock today depends on
The expected future dividends and the discount rate
A company forecasts growth of 6% for 5 years and 3% thereafter. Given last year's cash flow was $100, what is the horizon value if the company cost of capital is 8%?
The future value at 5 years of 100 is 133.82. The horizon value = 133.82/(.08 - .03)
If investors have a marginal tax rate of 20% and a firm has announced a dividend of $5;
The price of stock should decrease by $4 on the ex-dividend date
Generally, the book value of the shareholders' equity is represented by:
The sum of the par value of common stock, the capital surplus and the accumulated retained earnings
The cash budget is the primary short-run financial planning tool. The key reasons a cash budget is created are:
To estimate the size and timing of your new cash flows to prepare for potential financing needs
Total capitalization is defined as:
Total long-term liabilities + stockholders' equity
If a corporation cannot use its interest payments to get tax shield for a particular year because it has suffered a loss, it is still possible to get the tax shield because of the:
carry back provision carry forward provision
financial slack includes
cash marketable securities readily salable real assets ready access to debt markets or bank loans
Generally initial public offerings (IPOs) are:
UNDERPRICED
Internal funds make up more than two-thirds of corporate financing in the following countries:
US only
Which of the following countries allow firms to keep two separate sets of books, one for the stockholders and one for the tax authorities like the Internal Revenue Service?
US only
MM's proposition I corrected for the inclusion of corporate income taxes is expressed as
V = Ve + Tc(D)
Which of the following statements is generally true of venture capital (VC) firms?
VCs generally provide management advice and contacts in addition to capital
When preferred stock financing is also used by the firm; the after-tax weighted average cost of capital (WACC) is calculated as follows,
WACC = rD (1 - Tc)(D/V) + rP (P/V) + rE (E/V); (where V = D + P + E)
Leveraged buyouts (LBOs) almost always involve:
a large part of the purchase price is financed by debt most of the debt is below investment grade the firm goes private and its shared are no longer traded on the open market
the written agreement between a corporation and its bondholders contains a limitation on the dividends that the corporation can pay. this limitation is called
a negative covenant
preferred stock
a nonvoting share of ownership in a corporation that pays a fixed dividend
SEC registration is not required when a company makes
a private placement of securities a public offering of securities issue of value less than $5 million and maturity less than 9 months
income stock
a stock which pays higher than average dividends because the company chooses to retain only a small portion of the profits limited growth opportunities
preferably, cash flows for a project are estimated as
cash flows after taxes
What would best explain the reluctance of General Motors to eliminate its dividend in 2008, only a few months before its financial collapse and eventual government takeover?
clientele effect
A corporate bond that can be exchanged for a fixed number of shares of stock is called a
convertible bond
debt in disguise
accounts payable lease unfounded obligation
If a shareholder or an investor wants to acquire a new share of stock under a rights issue, he/she must:
acquire the appropriate number of rights per share and subscription price per share and submit them to the subscription agent
Capital budgeting decisions that include both investment and financing decisions can be analyzed by:
adjusting the present value and discount rate
In a uniform-price auction:
all winning bidders pay a price that is the lowest winning bid
capital surplus
amount of directly contributed equity capital in excess of par value
when a firm has no debt, it is known as
an unlevered firm, an all-equity firm
for an all equity firm
as EBIT increases, EPS increases by the same percent
The indifference proposition regarding dividend policy:
assumes that investors are indifferent towards the timing of dividend payments
Maximum number of shares that can be issued by a firm is called
authorized shares
the recovery rate on defaulting debt is the highest for the following type of debt
bank debt
The MM theory with taxes implies that firms should issue maximum debt. In practice, this is not true because:
bankruptcy and its attendant costs is a disadvantage of debt the payment of personal taxes may offset the tax benefit of debt
Generally, underwriters may handle an issue on:
best efforts basis firm commitment basis all or none basis
State laws that regulate sales of securities within the state are called:
blue sky laws
dividends are decided by
board of directors
the value of a bond is given by
bond value = asset value - value of a call option on assets
the call policy that maximizes shareholder wealth is to call a bond issue when
bonds price equals or exceeds the call price
the managing underwriter is also called
bookrunner
Generally, firms resort to repurchase of stock during
boom periods at an increasing rate when they are accumulating more cash
In the case of Google, which has issued Class A and Class B shares:
both classes of shares have the same voting rights both classes of shares have different control rights
an investor can create the effect of leverage on his/her account by
buying equity of an unlevered firm and borrowing on his/her account
One key assumption of the Miller and Modigliani (MM) dividend irrelevance is that:
capital markets are efficient
profitability index is useful under
capital rationing
the profitability index can be used for ranking projects under
capital rationing at t=0
a poison pill defense may be implemented by
issuing rights at a cheap price
the following are examples of spin-offs except
exxon and mobil
If investors do not like dividends because of the additional taxes that they have to pay, how would you expect stock prices to behave on the ex-dividend date?
fall by less than the dividend amount
When stock goes ex dividend:
falls by the amount of the dividend
Lowering debt-equity ratio of a firm can change:
financing proportions cost of equity cost of debt effective tax rate
Which of the following statement(s) about financial distress is(are) true:
firms can postpone bankruptcy for many years ultimately the firm may recover and avoid bankruptcy altogether
Generally, firms resort to repurchase of stock because:
firms have accumulated large amounts of excess cash firms want to change their capital structure
Which of the following is not true?
firms have long-run target div payout ratios
Which of the following statements about partnership and limited liability is(are) true?
general partners in a partnership cannot have limited liability general partners can be corporations only limited partners in a partnership can have limited liability
compensation paid to top management in an event of a takeover is called a
golden parachute
The rightist position is that the market will reward firms that:
have HIGH dividend yields
The most important difference between stock repurchases and cash dividends is that they:
have different effects on corporate cash flow
Inclusion of restrictions in the bond contract leads to:
higher agency costs
Pfizer's acquisition of Pharmacia is an example of a
horizontal merger
Daimler-Benz's acquisition of Chrysler is an example of:
horizontal merger & cross-border merger
the pecking order theory of capital structure predicts that
if two firms are equally profitable , the more rapidly growing firm will borrow more, other things equal
Generally, there is a drop in the price of equity subsequent to the announcement of a new issue. This is attributed to:
information effect
Generally (during the years 1989-2006), non-financial US corporations have financed their capital expenditures mostly through
internally generated cash
The dividend-irrelevance proposition of Miller and Modigliani depends on the following relationship between investment policy and dividend policy
investment policy is set before the dividend decision and not changed by dividend policy
Suppose that a company can direct $1 to either debt interest or capital gains for equity investors. If half of equity income were subject to personal tax (e.g.: half is taxable dividends and half is tax-free capital gains) which investor would not care how the money is channeled? (The corporate tax rate is 35%)
investors paying a personal tax rate of 53%
Suppose that a company can direct $1 to either debt interest or capital gains for equity investors. If there were no personal taxes on capital gains, which of the following investors would not care how the money was channeled? (The corporate tax rate is 35%)
investors paying personal tax of 35%
According to behavioral finance investors prefer dividends because:
investors prefer the discipline that comes from only spending the dividends
shelf registration is more often used for
issue of corporate bonds
Which of the following statements is/are true of limited partnerships:
limited partners enjoy limited liability generally limited partners put up most of the money generally limited partners are institutional investors
generally, high growth stocks pay
low or no dividends
what is the likely impact on a typical investor if a firm undertakes a stock repurchase in lieu of a cash dividend
lower income taxes, if cap gains tax rates are less than dividend tax rates
in order to calculate the tax shields provided by debt, the tax rate used is the
marginal tax rate
in the case of freely traded resources, opportunity cost is the
market value
One key assumption of the Miller and Modigliani (MM) dividend irrelevance argument is that:
new shares are sold at a fair price
The following statements are true of dividend reinvestment plans (DRIPs):
offered by companies to their shareholders new shares issued at discount dividends are taxable as income
According to the trade-off theory of capital structure:
optimal capital structure is reached when the present value of tax savings on account of additional borrowing is just offset by increases in the present value of costs of distress.
Which of these dates occurs last in time (when arranged in the chronological order)?
payment date
As a defensive maneuver, a firm issues deep-discount bonds that are redeemable at par in the event of an unfriendly takeover. These bonds are an example of:
poison put
When shareholders pursue selfish strategies such as taking large risks or paying excessive dividends, these will result in:
positive agency costs, as bondholders impose various restrictions and covenants, which will diminish firm value
Under the trade off theory, how will a government loan guarantee impact financing?
prefer to issue debt
When an entire security issue is directly sold to qualified institutional investors, such an issue is called a:
private placement
The costs of financial distress depend on the:
probability of financial distress magnitude of costs encountered if financial distress occurs
Which of the following statements describes shelf registration best?
provision that allows large companies to file a single registration statement covering financing plans up to two years in the future
A grant of authority allowing someone else to vote shares of stock that you own is called a:
proxy voting
The Granite Paving Company has a debt equity ratio of 1.5. The before-tax cost of debt is 11% and the unlevered equity is 14%. Calculate the weighted average cost of capital for the firm if the tax rate is 33%.
rE = 14 + (1.5)(1 - 0.33)(14 - 11) = 17%;WACC = (3/5)(1 -0.33)(11) + (2/5)(17) WACC = 11.22%
Modigliani-Miller (MM) formula for after-tax discount rate is given by:
rMM = r(1 - TcD/V)
The following are the main characteristics of financial intermediaries
raise money in special ways invest in financial assets
investment in inventories includes investment in
raw materials works-in-progress finished goods
Project X has the following cash flows: C 0 = +2000, C1 = -1,300 and C2 = -1,500. If the IRR of the project is 25% and if the cost of capital is 18%, you would:
reject the project loan project, only accept if IRR < cost of capital
What dividend policy is probably the best from a financial standpoint, but not likely to be accepted by the market place or investors?
residual dividend
internally generated cash is calculated as
retained earnings + depreciation
the trade-off theory of capital structure implies that
safe firms should borrow more than risky ones
The main reason for recent migration of a large number of firms from public-to-private ownership is:
sarbanes oxley act
the following are examples of growth stocks except
scottish power
the following are advantages of shelf-registration except
securities can be offered in dribs and drabs without incurring excessive transaction costs securities can be issued in short notice security issues can be timed to take advantage or market conditions
Big gainers from LBOs were
selling stockholders
Preference in position among creditors when it comes to repayment is called:
seniority
net working capital is best represented as
short term assets and short term liabilities
If dividends are taxed more heavily than capital gains, the investors:
should be willing to pay more for stocks with low dividend yields
According to Rajan and Zingales study, debt ratios of individual companies depend on:
size tangible assets profitability market to book
a "samurai bond" is a bond that
sold in Japan by a company from some other country
underwriters are typically compensated for their services in helping firms issue new securities in the form of a
spread
Which of the following dividends is never in the form of cash?
stock dividend
what signal is sent to the market when a firm decides to issue new stock to raise capital
stock price is too high
assuming bonds are sold at a fair price, benefits from tax shield go to
stockholders
One of the indirect costs of bankruptcy is the incentive for managers to take large risks. When following this strategy:
stockholders turning down low risk projects that might have positive NPVs stockholders would declare and receive high cash dividends
Generally, which of the following issues have the lowest total direct costs of issuing as a percentage of gross proceeds?Generally, which of the following issues have the lowest total direct costs of issuing as a percentage of gross proceeds?
straight bonds
Germany allows firms to choose the following depreciation methods:
straight-line method and declining-balance method
For example, in the case of an electric car project, which of the following cash flows should be treated as incremental flows when deciding whether to go ahead with the project?
tax savings resulting from the depreciation charges
if an acquisition is made using cash payment then the acquisition is
taxable
According to middle-of-the-roaders, a firm's value is not affected by its dividend policy because:
the clientele effect tax loopholes signaling theory for high dividends
Conglomerate discount means:
the market value of the conglomerate is less than the sum of the value of the parts
The following functions are provided by financial intermediaries for the smooth functioning of the economy:
the payment mechanism borrowing and lending pooling risk
In Miller's model, when the quantity (1 - Tc)(1 - TpE) = (1 - Tp), then:
the tax shield on debt is exactly off set by higher personal taxes paid on interest income
Clientele Effect
the tendency of a firm to attract a set of investors who like its dividend policy
Generally, managers of corporations prefer internally generated cash to finance their capital expenditures because
they can avoid the discipline of the financial markets cost of issuing new securities is high announcement of new equity is usually bad news for investors
The following are the main characteristics of financial intermediaries EXCEPT
they mainly invest in real assets
the top motive for CFOs to go public is
to create public shares for future acquisitions
Stockholders usually have the following rights:
to elect board members, authorize issue of new shares and vote on matters of great importance to share proportionally in regular and liquidating dividends to share proportionally in any new stock sold
Shares of stock that have been repurchased by the corporation are called
treasury stock
exploitation of the minority shareholders by the majority shareholders is called
tunneling
what cost in an IPO generally exceeds all other costs
underpricing
Dutch auction process is the same as:
uniform price auction
When financial distress is a possibility, the value of a levered firm consists of:
value of firm if all equity financed + PV of tax shield - PV of costs of financial distress
Walt Disney's acquisition of ABC television network is an example of:
vertical merger
Which of the following instruments gives the owner the right to purchase securities directly from the firm at a fixed price during a specified period of time?
warrant
According to financial executives' views about dividend policy, the following statement is the most frequently cited one:
we try to avoid reducing the dividend
If an investment project (normal project) has IRR equal to the cost of capital, the NPV for that project is:
zero
if an investment project (normal project) has an IRR equal to the cost of capital, the NPV for that project would be
zero
Project M requires an initial investment of $25 millions. The project is expected to generate $2.25 millions in after-tax cash flows each year forever. If the weighted average cost of capital (WACC) is 9% calculate the NPV of the project.
zero NPV = -25 + 2.25/0.09 = 0
A firm forecasts of cash flows ($millions) in years 1 thru 4 to be $120, $130, 135, and $137, respectively. If the project ends at the end of the fourth year, what is the horizon value given the company has historical growth of 3% and a discount rate of 10%? (answers in $millions)
$0 if project terminates, there is no horizon value
Universal Air is a no growth firm and has two million shares outstanding. It is expected to earn a constant 20 million per year on its assets. If all earnings are paid out as dividends and the cost of capital is 10%, calculate the current price per share for the stock.
$100 EPS = DPS = 20/2 = $10 per share = Po = 10/0.1 = 100
one calculates the after-tax WACC using which of the following formulas
(ROD - (1-T))(D/V) + (ROE)(E/V)
The dividend yield reported as Yld. % in The Wall Street Journal quotation is calculated as follows
(dividends/close)
What would be the weighted average profitability index of the following two investments, given the firm only has $250 to invest? Project A: Cost = $120, NPV = 80 Project B: Cost = $100, NPV = 75
0.62 (80/120) × (120/250) + (75/100) × (100/250)
Health and Wealth Company is financed entirely by common stock that is priced to offer a 15% expected return. If the company repurchases 25% of the common stock and substitutes an equal value of debt yielding 6%, what is the expected return on the common stock after refinancing? (Ignore taxes.)
18% rE= rA + (D/E)(rA-rD) = 15 + (0.25 / 0.75)(15-6) = 18%
The cost of a new machine is $250,000. The machine has a 3-year life and no salvage value. If the cash flow each year is equal to 40% of the cost of the machine, calculate the payback period for the project:
2.5 years cash flow each year = (0.4)(250,000) = 250,000; payback period = 2.5 years
Super Computer Company's stock is selling for $100 per share today. It is expected that this stock will pay a dividend of 6 dollars per share, and then be sold for $114 per share at the end of one year. Calculate the expected rate of return for the shareholders.
20% r = (114 + 6 - 100)/100 = 20%
If the Volume is reported in 100s as 292,059 in the Wall Street Journal quotation, then the trading volume for that day of trading is:
29,205,900
the survey of CFOs indicates that the IRR method is used for evaluating investment projects by
76% of firms
what are characteristics of preferred stock
A fixed rate of return - A preferred stock's fixed dividend is a key attraction for income-oriented investors. Adjustable-rate preferred - Some preferred stocks are issued with adjustable, or variable, dividend rates. Such dividends are usually tied to the rates of other interest rate benchmarks such as Treasury bill and money market rates, and can be adjusted semiannually. Limited Ownership privileges - Most preferred stock does not have voting or preemptive rights. No maturity date or set maturity value - Unlike bonds preferred stock have no preset maturity date or scheduled redemption date.
profitability index is the ratio of
Net present value of cash flows to investment
the expected rate of return or the cost of equity capital is estimated as follows
dividend yield + expected rate of growth in dividends
M&M Proposition II states that
expected return on equity is positively related to leverage required return on equity is a linear function of a firms debt to equity ratio risk to equity increases with leverage
the pecking order theory of capital structure implies that
firms prefer internal finance and prefer debt to equity when external financing is required
a puttable provision in a bond allows the
holder to redeem the bond at par before maturity
under what conditions would a policy of maximizing the value of the firm not be the same as a policy of maximizing shareholders wealth
if an issue of debt affects the value of existing debt
the main difference to shareholders between a tax-free and a taxable acquisition is that
in a tax free acquisition the shares are only exchanged while in a taxable transaction the shares are considered sold and realized capital gains or losses are taxed
As CFO of your corporation, you would prefer (all else equal) to see the price of your corporation's bonds:
increase, indicating firms view your bonds as less risky
When a firm has the opportunity to add a project that will utilize excess factory capacity (that is currently not being used), which costs should be used to determine if the added project should be undertaken?
incremental costs
for the case of an electric car project, the following costs should be treated as incremental costs when deciding whether to go ahead with the project EXCEPT for
interest payments on debt incurred to finance the project (assume all equity-financed)
when comparing levered vs. unlevered capital structures, leverage works to increase EPS for high levels of operating income because
interest payments on the debt stay fixed, leaving more income to be distributed over less shares
if an individual wanted to borrow with limited liability he/she would
invest in the equity of a levered firm
an investor can undo the effects of leverage on his/her account by
investing in the equity of a levered firm, by investing in risk-free debt like T-bills
different classes of stocks are usually issued in order to
maintain ownership control by holding the class of stock with greater voting rights
arrange the following assets in decreasing order of liquidity
marketable securities, accounts receivables, inventories, equipment and machinery
important points to remember while estimating cash flows of projects are
only cash flow is relevant always estimate cash flows on an incremental basis be consistent in the treatment of inflation
The cost of a resource that may be relevant to an investment decision even when no cash changes hand is called a (an):
opportunity cost
the value of a previously purchased machine to be used by a proposed project is an example of
opportunity cost
which of the following investment rules may not use all possible cash flows in its calculations?
payback period
dividend growth rate for a stable firm can be estimated as
plowback rate x ROE
which of the following is an example of a liquidity ratio
quick ratio
the following stocks are examples of income stocks except
starbucks
which of the following stocks is a growth stock
starbucks
which of the following actions by an acquiring firm signals its belief that post-merger gains will be substantially larger than expected?
the acquiring firm makes a cash offer, since this allows the acquirer to solely benefit from the gains not reflected in the market
which of the following is true regarding the discounted payback period rule is true?
the discounted payback rule uses the time value of money concept
the opportunity cost of capital for a risky project is
the expected rate of return on a security of similar risk of the project
a policy of maximizing the value of the firm is the same as a policy of maximizing the shareholder wealth rests on two assumptions. they are
the firm can ignore dividend policy and an issue of new debt doesnt affect value of existing debt
the effect of financial leverage on the performance of a firm depends on
the firm's level of operating income
capital structure of the firm can be defined as
the firms mix of securities used to finance assets
M&M proposition I states that
the market value of any firm is independent of their capital structure
the law of conservation of value states that
the value of any asset is preserved regardless of the nature of claims against it
one should consider net working capital in project cash flows because
typically firms must invest cash in short-term assets to produce finished goods
generally, IPOs are
underpriced