FINC 3304 Final Exam Review

A firm has 100,000 shares of stock outstanding. The firm is considering borrowing $13 million at 7.5% interest and using the loan proceeds to repurchase 10,000 shares of stock. What is the value of the firm? Ignore taxes. $52.0 million $59.8 million $130.0 million $13.0 million

$130.0 million =(13000000/10000)*100000

The Seattle Corp. is considering a new project. The firm has already paid $10,000 consulting fee for the feasibility analysis of the project. The project costs $210,000 to purchase buildings and equipment, $20,000 for shipping fee, and $20,000 for installation fee. Compute the depreciation basis of the project. $260,000 $250,000 $240,000 $230,000

$250,000 Depreciation basis= cost of project+Shipping cost+installation fees =210000+20000+20000= $250,000

A firm is considering an investment project with the following cash flows: Year 0 = -$125,000 (initial costs); Year 1= $35,000; Year 2 =$85,000; and Year 3 = $25,000; and Year 4 = $55,000. The company has an 8.8% cost of capital. Calculate the NPV for the project. $37,637 $64,264 $43,297 $55,381

$37,637 Year (i): 0, 1, 2, 3, 4 Cash flow (CFi): $125,000, $35,000, $85,000, $25,000, $55,000 Cost of capital, r = 8.8% = 0.088 NPV = CF0 + CF1/(1 + r)^1 + CF2/(1 + r)^2 + CF3/(1 + r)^3 + CF4/(1 + r)^4 NPV = -125,000 + 35,000/(1 + 0.088)^1 + 85,000/(1 + 0.088)^2 + 25,000/(1 + 0.088)^3 + 55,000/(1 + 0.088)^4 NPV = -125,000 + 35,000/1.088 + 85,000/1.183744 + 25,000/1.287913472 + 55,000/1.4012498575 NPV = -125,000 + 32,169.1176470588 + 71,806.0661764706 + 19,411.2419378435 + 39,250.673037089 NPV = $37,637.0987985 The NPV for the project is $37,637.10

A firm currently has 200,000 shares of stock outstanding at a market price per share of $120. Today, the firm announced a 3-for-1 stock split. The stock increased 10% after the announcement. What will the price per share be after the split? $44.0 $132.0 $40.0 $42.0

$42.0

A company is an all-equity firm that has projected earnings before interest and taxes (EBIT) of $500,000 forever. The current cost of equity rs = 8% and the tax rate T = 20%. The company is in the process of issuing $1.5 million of bonds at par that carry a 6% annual coupon. What is the unlevered value of the firm (in millions)? (Note: You should use MM capital structure model with corporate taxes, but without personal taxes and bankruptcy costs. The formula for the value of unlevered firm: VU = EBIT x (1-T) / rs). $4.00 million $5.00 million $2.86 million $4.50 million

$5.00 million =500000*((1-.2)/.08)

According to the information from Question 9, what is the levered value of the firm (in millions)? (Note: The value of levered firm VL = VU + Present value of annual interest tax shield) $4.30 million $4.60 million $5.00 million $5.30 million

$5.30 million 5000000*.06=300000 5000000+300000=5.3 million

An investor purchased 300 shares of ABC Inc. stock on December 18. ABC paid its quarterly dividend of $1.10 a share on December 31. The record date was December 18. How much dividend income did the investor receive on December 31 from his investment in ABC stock? $0.00 $110 $165 $330

0

An investor has a $100,000 stock portfolio. $32,000 is invested in a stock with a beta of 0.75 and the remainder is invested in a stock with a beta of 1.38. These are the only two investments in his portfolio. What is his portfolio's beta? 0.75 1.18 1.29 1.38

1.18 Portfolio beta = ((32000/100000)*.75) + (((100000-32000)/100000)*1.38) =1.1784 =1.18

Suppose your company has an equity beta of 1.5 and the current risk-free rate is 3.0%. If the expected market risk return is 8.0%, what is your cost of equity capital? 10.5% 11.6% 12.3% 15.0%.

10.5% <-- Right answer The Cost of Common Equity = Risk-free Rate + [Beta x Market Risk Premium] =.03+(1.5*.08) =.15 =15%

A stock sells for $20 per share, its last dividend (D0) was $1.00, and its growth rate is a constant 6%. What is its cost of common stock? 5.3% 11.0% 11.3% 11.6%

11.3% Cost of common stock = [D0(1 + g) / P0] + g Where, Dividend in next year (D0) = $1.00 per share Dividend growth rate (g) = 6% per year Current Share Price (P0) = $20.00 per share

A company's stock has a beta of 1.4, the risk-free rate is 4.25%, and the market return is 8.75%. What is its required rate of return? 4.25% 9.97% 11.95% 12.83%

11.95% I think this question was messed up. The actual answer was 10.55%. Had the market return been 9.75%, then we would have gotten 11.95%. Here are the processes for both market return values: Required rate of return = risk free rate + beta*(market return - risk free rate) ---for market value of 8.75%--- =.0425 + 1.4(.0875-.0425) =.1055 =10.55% ---for market value of 9.75%--- ==.0425 + 1.4(.0975-.0425) =.1195 =11.95%

An investor owns 1000 shares of stock in ABC Corp. with a market value of $1,100. ABC declares a 10% stock dividend. After the dividend is paid, John owns ____________ 1000 shares with a market value of $1,000. 1000 shares with a market value of $1,100. 1100 shares with a market value of $1,100. 1100 shares with a market value of $1,000.

1100 shares with a market value of $1,100.

A firm has a debt-equity ratio of 1.0. The required return on the firm's assets is 10.1% and the pre-tax cost of debt is 4.1%. Ignore taxes. What is the firm's cost of equity? 19.3% 18.1% 26.1% 16.1%

16.1% cost of equity = the required rate of return on the firm's assets + (the required rate of return on the firm's assets - the firm's cost of debt) * the firm's debt-equity ratio =.101+(.101-.041)*(1)

The ex-dividend date is ________ the holder of record date. 2 days before. 1 day before. The same day as 2 days after.

2 days before.

A firm is considering an investment project with the following cash flows: Year 0 = -$125,000 (initial costs); Year 1= $35,000; Year 2 =$85,000; and Year 3 = $25,000; and Year 4 = $55,000. The company has an 8.8% cost of capital. Calculate the IRR for the project. 18.9% 21.7% 34.6% 26.3%

21.7% The IRR is the interest rate that makes the NPV of the project equal to zero. Excel: =IRR(A1:A5) A1:A5 is the column of all the cash flows. IRR = 21.7%

A firm is considering an investment project with the following cash flows: Year 0 = -$125,000 (initial costs); Year 1= $35,000; Year 2 =$85,000; and Year 3 = $25,000; and Year 4 = $55,000. The company has an 8.8% cost of capital. What is the project's payback? 2.67 years 2.81 years 2.20 years 3.04 years

3.04 years Year 1 cash flow : = $ 35,000/1.088 = $ 32,169.1175 Year 2 cash flow : = $ 71,806.0662 Year 3 cash flow : = $19,411.2419 Year 4 cash flow : = $ 39,2506.673 Discounted payback is : = 3 + ( 125,000 - 123,386.4256)/ $38,250.673 = 3.04 years APPARENTLY THIS IS WRONG ABOVE SO: So the discount payback = 2 + $5,000/ $25,000 = 2.2 years.

If a firm's before-tax cost of debt is 5% and the firm has a 21% marginal tax rate, what is the firm's after-tax cost of debt? 5.0% 3.95% 5.21% 6.05%

3.95% .05*(1-.21)=.0395

A stock has a 50% chance of producing a 10% return, a 30% chance of producing a 5% return, and a 20% chance of producing a -10% return. What is the stock's expected return? 2.5% 4.5% 6.0% 7.5%

4.5% Expected Return = Weight of Stock A*Expected Return on Stock A + Weight of Stock B*Expected Return on Stock B =(.5*.1)+(.3*.05)+(.2*-.1) =.045 =4.5%

You own a $20,000 portfolio consisting of two stocks, A and B. Stock A is valued at $10,000 and has an expected return of 10%. Stock B has an expected return of 5%. What are the weights of stock A and B in the portfolio? 33%, 67% 50%, 50% 40%, 60% 60%, 40%

50%, 50% (10000/20000) x 100% = 50% ((20000-10000)/20000) x 100% = 50%

A firm has 50,000 shares of stock outstanding, net income of $50,000, and a PE ratio of 15. What will the firm's PE ratio be if the firm repurchases 30,000 shares? Assume all else remains constant. 10.0 15.0 6.0 7.5

6 Numbers of shares outstanding: 50,000 Net income shares: 50,000 Market price per share = PE ratio x EPS =15 x 50000/50000 =15 Revised EPS = old earnings/repurchased shares =50000/30000 =1.666666667 PE ratio = MPS/revised EPS =15/1.66666667 = $50,000/30,000=1.666667 $50,000/50,000=$10 10/1.6667=5.9999=6

A company has preferred stock that can be sold for $100 per share. The preferred stock pays an annual dividend $6. Therefore, the cost of preferred stock is: 4.0% 5.0% 6.0% 10.0%

6.0% 6/100=.06

Based on the information from Question 6, what is the expected return on the portfolio? 7.0% 7.4% 7.5% 10.0%

7.5% Expected Return = Weight of Stock A*Expected Return on Stock A + Weight of Stock B*Expected Return on Stock B = (.5*.1) + (.5*.05) =.075 =7.5%

A firm has a target capital structure of 30% debt, 20% preferred stock, and 50% common equity. The company's after-tax cost of debt is 5%, its cost of preferred stock is 8%, and its cost of retained earnings is 12%. The firm's marginal tax rate is 21%. What is the company's weighted average cost of capital if retained earnings are used to fund the common equity portion? 8.0% 9.50% 9.10% 8.79%.

=9.10% Weighted Average Cost of Capital (WACC) = [After Tax Cost of Debt x Weight of Debt] + [Cost of Preferred stock x Weight of preferred stock] + [Cost of equity x Weight of Equity] =(.05*.3)+(.08*.2)+(.12*.5) =.91 =9.10%

Which one of the following is an example of diversifiable risk? Income tax rates are revised by the federal government. The unemployment rate drops to 4.5%. The Fed lowers its discount rate. A firm shrinks its product market share.

A firm shrinks its product market share.

A stock is expected to return 13% in an economic boom, 10% in a normal economy, and 3% in a recessionary economy. Which one of the following will increase the overall expected rate of return on this stock? A increase in the probability of a recession occurring A decrease in the probability of an economic boom An increase in the probability of an economic boom An decrease in the rate of return in a recessionary economy

An increase in the probability of an economic boom

If D represents debt, E represents equity, and the firm has preferred stock (P), then the capital structure weight of equity is computed as: E/D E/(D+E) E/(D+E+P) E/ (E+P)

E/(D+E+P) Weight of Equity = Equity/(Equity + Debt + Preferred Stock)

A firm declared a dividend of $2 per share, which was an increase of 25% from the prior year, yet the stock declined by 3% the day of the announcement. Another firm declared a dividend of $2 per share, which was the same as the prior year, and its stock increased in value by 2% on the day of the announcement. These events could be most readily explained by the _________ Information effect. Residual dividend theory. Clientele effect. Expectations theory.

Expectations theory.

Which one of the following is the additional risk arising from the borrowing debt of a firm? Business risk Financial risk Operating risk Strategic risk

Financial risk

For two mutually projects, we assume their NPV profiles cross and the crossover rate is 9.3%. We assume the require rate of return is r. We use both NPV and IRR methods to analyze the two projects. Which of the following statements is most correct? If r > 8.3%, NPV and IRR methods always obtain similar decisions. If r > 9.3%, NPV and IRR methods obtain conflicting decisions. If r < 8.3%, NPV and IRR methods might obtain conflicting decisions. None of the above statement is correct.

If r < 8.3%, NPV and IRR methods might obtain conflicting decisions. EXPLANATION: When (1) r > crossover rate, NPV and IRR methods get similar decisions; (2) r < crossover rate, NPV and IRR methods may get conflicting decisions

Which one of the following is the slope of the security market line? Risk-free rate Market risk premium Beta coefficient Market rate of return

Market risk premium

The systematic risk principle states that the expected return on a risky asset depends only on which one of the following? Company-specific risk Diversifiable risk. Systematic risk Unsystematic risk

Systematic risk

Which of the following statements is not correct? Independent projects are defined as the cash flows of one are unaffected by the acceptance of the other. Mutually exclusive projects are defined as the cash flows of one can be adversely impacted by the acceptance of the other. The IRR approach can be used to evaluate both independent projects and mutually exclusive projects. The MIRR approach can be used to evaluate both independent projects and mutually exclusive projects.

The IRR approach can be used to evaluate both independent projects and mutually exclusive projects. EXPLANATION: The IRR approach can be used to evaluate independent projects, but not mutually exclusive projects.

What of the following statements about the IRR and MIRR methods is not correct? The IRR approach cannot be used to evaluate the projects with non-normal cash flows. The IRR approach assumes the reinvestment rate is IRR rather than WACC. The IRR approach might draw conflicting results when evaluation the mutually exclusive projects. The MIRR approach has the similar problems associated with the IRR approach.

The MIRR approach has the similar problems associated with the IRR approach. EXPLANATION: The MIRR approach has solved the problems associated with the IRR approach. IRR approach must not be used for non normal cashflow. An IRR reinvestment is considered at IRR rate. IRR might give conflicting results. MIRR is a modified version of IRR when reinvestment is assumed at a specified rate. Hence, remove the problem of IRR.

Which one of the following is a logical assumption concerning capital structure weights? The weights are constant over time. A new bond issue will increase the weight of the firm's preferred stock. The redemption of a bond issue will decrease the weight of the firm's debt. The issuance of additional shares of common stock will not change the weight of the preferred stock.

The redemption of a bond issue will decrease the weight of the firm's debt.

Which one of the following statements is correct? To maximize the value of a firm you need to maximize the firm's WACC. A Chapter 7 bankruptcy is a legal process for reorganizing a firm. Investors cannot use homemade leverage to offset firm leverage. To maximize the value of a firm you need to maximize shareholder of wealth by optimizing capital structure and others.

To maximize the value of a firm you need to maximize shareholder of wealth by optimizing capital structure and others.

If a firm paid $30,000 for a consulting firm for the feasibility analysis of a project. The present value of all other estimated cash inflows and cash outflows which are related to this project is $5,000. Should the investment be taken? Yes No

Yes NVP>0 better than nothing.

If a project has NPV = 0, what types of following investors should have received their required rate of return from this project? Bondholders Preferred Stockholders Common Stockholders All of the above capital providers.

all of the above capital providers EXPLANATION: Since we use WACC as discount rate when we calculate NPV, all stakeholders (bondholders, preferred stockholders, common stockholders) are expected to receive their required rate of return (the minimum return to compensate the risk) when NPV = 0. Project NPV equals zero when the IRR equals the weighted average cost of capital (WACC) WACC is computed using the required rate of return of all investors, i.e. Bondholders, Preferred Stockholders and Common Stockholders. Hence, if the NPV equals zero, all the investor should have received their required rate of return The answer is - "all of the above"

The cost of a particular source of capital (debt, preferred stock, common stock) is equal to the investor's required rate of return. True False

false

NPV assumes that the reinvestment rate on cash flows is equal to the cost of capital (WACC), but MIRR assumes that the reinvestment rate on cash flows is equal to MIRR. True False

false EXPLANATION: NPV assumes that the reinvestment rate on cash flows is equal to the cost of capital (WACC), and MIRR also assumes that the reinvestment rate on cash flows is equal to WACC. Only IRR assumes that the reinvestment rate on cash flows is equal to IRR. The NPV has no reinvestment rate assumption; therefore, the reinvestment rate will not change the outcome of the project. The MIRR has a reinvestment rate assumption that assumes that the company will reinvest cash inflows at the MIRR's rate of return for the lifetime of the project

The residual dividend theory suggests that dividends should be paid to stockholders first and then what is left can be reinvested by the firm. True False

false According to Residual dividend theory, the earnings shall be utilized for expansion purpose and the leftover earnings can be distribuited as dividend to stock holders.

A preferred stock is valued as a: constant growth stock. fixed coupon rate bond. zero coupon stock. perpetuity.

perpetuity

According to the static theory of capital structure, a firm borrows up to which one of the following points? point where the firm is financed totally with debt point where an additional dollar of debt would have a benefit exactly equal to its cost point where WACC equals the debt-equity ratio point where the debt-equity ratio equals 1.0

point where an additional dollar of debt would have a benefit exactly equal to its cost

Which of the following is considered a capital component for the purpose of calculating the weighted average cost of capital (WACC)? Accounts payables Accruals Short-term debt Preferred stock.

preferred stock

According to M&M Proposition I with taxes, the value of a levered firm is equal to the value of the unlevered firm plus which one of the following? current market value of the debt par value of the debt present value of the depreciation tax shield present value of the interest tax shield

present value of the interest tax shield

In a Chapter 7 bankruptcy, which one of the following will have the highest priority when a bankrupt firm's assets are distributed if the absolute priority rule is followed? preferred stockholders secured creditors unsecured creditors common shareholders

secured creditors

Which of the following transactions will not affect a corporation's retained earnings? stock repurchase increase dividend payments stock dividend cut dividend payments

stock dividend

Beta measures _____ risk while standard deviation measures _____ risk. systematic; total unsystematic; systematic total; unsystematic total; systematic

systematic; total

Which one of the following is probably the best argument in favor of a stock split? to lower the current stock price to its normal trading range to provide additional shares to all its shareholders to avoid delisting to increase the value of the firm

to lower the current stock price to its normal trading range

Different borrowers have different risks of bankruptcy, and bankruptcy is costly to lenders. Therefore, lenders charge higher rates to borrowers judged to be more at risk of going bankrupt. True False

true

The higher the dividend payout ratio, the more a company must rely on external financing. True False

true