111 Practice Final Exams

Student Number ___________
Corporate Finance Practice Final Exam I

3 hours
You have 3 hours to complete this exam
The exam is open book and open notes.
Please write your student identification number on every page of the exam. Please be as
concise as possible. All questions can be answered with dot points or simple diagrams.
Use the space provided on this exam paper to answer:
20 short answer questions for 5 points each. Answer ALL questions
___________________________________________________________________________
1. Mark each of the following statements as either true or false. 5 points for 5 correct answers, 3
points for 4 correct answers, 1 point for 3 correct answers. No explanation required.
a. Delivery in futures contracts is only notional, they are always settled in cash.
b. The futures price, F0, may be below the expected value of the spot price, E[S T], at the
maturity date.
c. An advantage of forward contracts over futures contracts it that because they can be
customised there they can have less basis risk.
d. Ignoring the real options in a project overstates the value of the project.
e. To build into a capital budgeting decision a level of comfort or fudge factor it is
better to increase the discount rate than to apply a uniform reduction to cashflows.
a. The valuation of depreciation credits can be maximized if a firm in a high tax country
leases equipment from a firm in a low tax country.
b. An investment bank can lock in a risk free borrowing rate by short selling Treasury
bonds.
c. A firm with negative net debt has a lower cost of equity capital than a firm with positive
net debt.
d. Changes in the trade credit payment policy of a firm are a leading indicator of the
financial health of the firm.
e. The trade-off theory of capital structure posits that a share buy-back will destroy value if
the leverage of the firm is below the optimal level.
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3. Your firm issues $US 600 million of 5 year notes priced at 85 bps over the 6 month $US
Libor. Explain, very briefly, how you would:
Hedge the interest rate risk with a swap contract
Hedge the currency risk with a swap contract
4. List the four main sources of liquidity that firms can draw on to manage the liquidity shock of
an unanticipated sale. No explanation required.
5. Four types of participants in the Treasury bond futures market are shown below. Beside each
bullet point, in one short sentence, give one reason why that participant might take the short
position in Treasury bond futures contracts.
Hedger:
Speculator:
Market maker:
Arbitrageur:
6. List the three main reasons that many firms take out a large bank loan even though the firm
can raise capital in the bond market at lower interest rates.
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7. A firm is considering the purchase of an undeveloped mining lease. The size of the ore body
must be proven in a drilling program. If a significant ore body is found then a mine must be
built. State simply what the following quantities are in this project:
The price of the real option to develop the mine:
The main source of uncertainty:
The optionality:
The strike price:
The underlying asset:
8. List, and briefly explain, the three main reasons that the firm that wins the auction in the
Antamina case may choose to lease, rather than buy, the equipment used to operate the mine.
9. Consider a fast growing retailer like JBHI (JB Hi Fi). List and briefly explain how the nature
of the balance sheet of the firm (asset ownership and financing characteristics) allow the firm
to grow so quickly.
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10. Imagine that Vicksburg hedge fund decides to speculate on the price of BHP oil price by
selling a call option on oil with a strike price of $100 per barrel and buying a put option on oil
with a strike price of $60. Draw a diagram with the pay-off at maturity (per barrel) of that
combination of put and call positions on the Y-axis and the price of oil at maturity on the X-
axis.
11. Imagine that you are on the T-bond futures arbitrage desk of an investment bank. You can
either borrow $100 million in cash for up to 6 months or short T-bonds with market value of
$100 million but not both. The cost of shorting the bonds for six months is 0.05% of value
paid in advance. The spot price of 10 year T-bonds is 100.73 (percent of their face value).
The six month futures price of bonds is 100.12. The bonds have a coupon rate of 4.35% and
the next coupon will be received three months from today. If 3 month Libor is 2.25% and 6
month Libor is 3.25% then what is the maximum arbitrage profit that you can make from this
opportunity.
12. The price of BHP shares is $50. The 6 month risk free rate is 5%. If at-the-money BHP call
options with six months to expiry are selling for $2.45, then what is the price of at-the-money
BHP put options with six months to expiry? Ignore dividends
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13. On average the customers of the Boro Inc pay invoices 48 days after the sale date. The
company decides to introduce a discount of 2 percent for customers who pay after 10 days. It
is expected that early payers and later payers are equally likely to take the discount. What
does the discount imply about Boros cost of capital tied up in financing receivables?
14. Aldo borrows 2,000,000 Qantas shares and sells them for $2.51 per share. Qantas pays a
dividend of $0.08 after 2 months and Aldo buys the shares back for $2.38 after 6 months. At
what APR has he effectively borrowed money over the 6 months?
15. The Lepanto Company has $100 million of cash, $30 million of which is operating cash.
The firm decides to use the excess cash plus the $80 million of a private placement of debt to
buy back shares in the firm. The current share price is $14 and the buyback will take place at
$15 per share. The effective corporate tax rate of the firm is 15%.
Calculate the total present value of tax shields in the buy back.
What proportion of the present value of tax shields (in percent) will go to the
shareholders who remain after the buyback?
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16. Sylvan Inc paid 8.5 times FCF for a Pectuk Inc. Sylvan expects the FCF of Pectuk to grow at
6% in perpetuity. What is Sylvans required return on capital in the purchase?
17. The Trebia Company is comparing the cost of buying rather than leasing machine tools. The
price to buy the equipment is $5.2 million. Purchased equipment can be depreciated straight-
line at 25% per year. Alternatively, a lease would have payments of $1.25 million per year,
with the first payment today. Trebia has an effective corporate tax rate of 30% and is
expecting to pay taxes that are large compared to this lease deal. Taxes will be paid at the
end of each year going forward. If Trebia after-tax cost of equity capital is 12%, then should
Trebia lease or purchase?
18. The Orantes Corporation is conducting financial planning. The firm cannot raise any new
debt or issue any new shares. All growth must be financed by retained earnings. The firm
has $100 million of debt and $200 million of equity. It cuts dividends to 30% of net income.
Sales per dollar of net assets are increased to $2. What net margin must the firm attain if it
wishes to grow sales at 20% per year?
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Use the following table to answer questions 19 and 20.
Maturity Libor zero rate

(years) 20 August 2010
0.5 5.15
1.0 5.60
1.5 5.95
2.0 6.20
2.5 6.35
3.0 6.45
19. Consider a 7 year fixed for floating interest rate swap with a notional value of $100 million
that was opened on 20 August 2006. On each 20 August or 20 February payment date the
fixed party recieves $3.61 million and the floating party recieves 6 month Libor (set six
months earlier). If 6 month Libor was 5.35% on 20 February 2010, then what is the value of
the swap to the party paying floating on 20 August 2010?
20. Calculate the swap rate on new 3 year fixed for floating rate swaps opened on 20 August
2010.
7 of 27
Corporate Finance Practice Final Exam II

3 hours
You have 3 hours to complete this exam

The exam is open book and open notes.
Please write your student identification number on every page of the exam. Please be as
concise as possible. All questions can be answered with dot points or simple diagrams.
Use the space provided on this exam paper to answer:
20 short answer questions for 5 points each. Answer ALL questions
___________________________________________________________________________
a. Customers with higher switching costs have lower value to a bank.
b. Factoring, or vendor financing, is a source of liquidity for firms.
c. If a firm uses excess cash to buy back its own shares then the firms required return on
equity increases.
d. Investors demand a liquidity premium that is approximately the round trip cost of buying
and then selling the asset, divided by the expected length of time the asset will be held.
e. In terms of sensitivity to interest rate changes the position of paying fixed in a fixed-for-
floating interest rate swap has negative duration.
a. The trade-off theory of capital structure says that firms do not have a target level of
leverage, but instead the level of leverage results from other decisions.
b. Firms give all customers the same trade credit terms.
c. Prinicipal is exchanged in currency swaps but not in interest rate swaps.
d. When the volatility of the underlying asset increases a call option on the asset increases in
value and a put option decreases in value.
e. The margin account of the long party falls when the futures price falls.
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3. Four types of participants in the oil futures market are shown below. Beside each bullet
point, in one short sentence, give one reason why that participant might take the short position
in an oil futures contract.
Hedger:
Speculator:
Market maker:
Arbitrageur:
4. Give one example of each of the following

Contracting cost of financial distress:
Loss of asset value in financial distress:
Lost opportunity cost of having high leverage:
5. Explain how private, family owned firms differ from large listed firms in the following areas
of financial policy:
Leverage:
Cost of capital:
6. Imagine that the St Barbara gold mining firm hedges the annual production from one of its
mines by buying an option to put gold at $1100 per oz and selling an option to buy gold at
$1300 per oz. Draw a diagram with the pay-off at maturity (per oz) of that combination of
put and call positions on the Y-axis and the price of gold on the X-axis.
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7. Explain, in just one or two sentences, two conflicts of interest that arise between shareholders
and debt holders when a firm approaches financial distress.

8. Consider the equation for the present value of debt shields: PV(debt shields) = D.T C
Explain how this equation is derived.
9. In what sense is trade credit the provision of liquidity?
10. Why does Qantas hedge more oil price risk than VirginBlue
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11. The Westphalia company offers its customers 90 days trade credit. Westphalia offers a
discount of 5% if customers pay within 15 days of purchase. What does the discount imply
about Westphalias cost of capital in financing receivables. Assume that all customers either
pay on the 15th day or on the 90th day.
12. The price of wheat today is $230 per tonne. The cost of storing wheat for one year (payment
in advance) is $25 per tonne and the 1 year Libor rate is 5.25 percent. What is the upper
bound on the futures price of wheat? (The price level beyond which there is an arbitrage
opportunity).
13. The price of BHP shares is $45 and one year Libor is 5.25 percent. Consider puts and calls
on BHP shares with one year to maturity. At what strike does the price of a put equal the
price of a call.
14. The total enterprise value of a firm is 6 times free cash flow (FCF), where FCF is received
one year from today. If FCF is expected to grow at 5% in perpetuity then what rate are the
cashflows being discounted at to give a TEV multiple of six.
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15. Fei River is the holding company of a foreign subsidiary named Yarmouk. Fei River is
leveraged to 0.4 with 6.5% debt. The required return on the assets of the subsidiary is 25%.
Yarmouk is geared to 0.3 with 9.2% debt, and has an effective corporate tax rate of 0.20. If
Fei River has an effective corporate tax rate of 30%, then what is its WACC?
16. Wally borrows 1000 Westpac shares and sells them for $25,450. After 2 months Westpac
pays a dividend of $0.81. Wally buys back the shares after 3 months for $27,250. At what
annual rate has Wally borrowed money over the 3 months?
17. The Toures Corporation is conducting financial planning. The firm has net working capital of
$200 million, long term assets of $400 million and long term debt of $150 million. The net
margin is 4.5%, the plowback ratio is 70% and the firm has sales of $1.5 billion. What level
of asset utilization does the firm have to achieve to reach a sustainable a growth rate of 15%?
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18. The Monteverde company is expected to pay $17.5 million in interest payments and $80
million in dividends in perpetuity. The yield on the debt is 7% and the required return on the
equity is 10%. The effective corporate tax rate is 15%.
Calculate the WACC of the firm.
Then use the WACC to discount the cashflows from the firm to show that the TEV of the
firm is $1050 million.

0.5 4.55
1.0 5.10
1.5 5.45
2.0 5.70
2.5 5.85
3.0 5.90
19. Consider a 3 year interest rate swap which is created on 11 August 2010. Fixed payments at
the swap rate are swapped for 6 month Libor twice per year. The notional value of the swap
is $100 million. Use the data in the table above to calculate the swap rate (annual percentage
rate of fixed rate payments).
20. Continuing from the previous question. Calculate the present value of the floating rate
payment that will be made on 11 February 2012.
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Corporate Finance Practice Final Exam I

Solution
3 hours
Note: This is not intended to be a model exam solution. Some of the

answers given here contain more information than was required for a full
grade. A model exam would have shorter answers than given here.
a. Delivery in futures contracts is only notional; they are always settled in cash. False
b. The futures price, F0, may be below the expected value of the spot price, E[S T], at the
maturity date. True
c. An advantage of forward contracts over futures contracts it that because they can be
customised they can have less basis risk. True
d. Ignoring the real options in a project overstates the value of the project. False
e. To build into a capital budgeting decision a level of comfort or fudge factor it is
better to increase the discount rate than to apply a uniform reduction to cashflows. True
a. The valuation of depreciation credits can be maximized if a firm in a high tax country
leases equipment from a firm in a low tax country. False
b. An investment bank can lock in a risk free borrowing rate by short selling Treasury
bonds. False
c. A firm with negative net debt has a lower cost of equity capital than a firm with positive
net debt. True
d. Changes in the trade credit payment policy of a firm are a leading indicator of the
financial health of the firm. True
e. The trade-off theory of capital structure posits that a share buy-back will destroy value if
the leverage of the firm is below the optimal level. False
14 of 27
3. Your firm issues $US 600 million of 5 year notes priced at 85 bps over the 6 month $US
Libor. Explain, very briefly, how you would:
Hedge the interest rate risk with a swap contract

Pay $US fixed and receive $US floating
In a 5 year swap fixed-for-floating interest rate swap
With $US Libor as the floating rate benchmark in the swap
Hedge the currency risk with a swap contract

Pay $A fixed and receive $US fixed
In a 5 year fixed for fixed currency swap
4. List the four main sources of liquidity that firms can draw on to manage the liquidity shock of
an unanticipated sale. No explanation required.
Cash held on the balance sheet
Bank lines of credit
Trade credit
Factoring or invoice financing
5. Four types of participants in the Treasury bond futures market are shown below. Beside each
bullet point, in one short sentence, give one reason why that participant might take the short
position in Treasury bond futures contracts.
Hedger: To hedge the risk of fixed rate debt.
Speculator: To profit from rise in interest rates.
Market maker: To take the opposite position to a party that wishes to take the long
position in the futures contract if the delivery price is high enough.
Arbitrageur: As part of a set of trades that will deliver an arbitrage profit if the futures
price is too high or too low.
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6. List the three main reasons that many firms take out a large bank loan even though the firm
can raise capital in the bond market at lower interest rates.
The loan is part of the overall relationship with bank which includes the provision of
liquidity.
Bondholders and shareholders have lower required return if the bank is monitoring the
firm.
Bank borrowing diversifies the sources of capital (you never know when the bond market
channel for debt capital will close).
7. A firm is considering the purchase of an undeveloped mining lease. The size of the ore body
must be proven in a drilling program. If a significant ore body is found then a mine must be
built. State simply what the following quantities are in this project:
The price of the real option to develop the mine:

(Purchase price of mine) + (Cost of the drilling program)
The main source of uncertainty:
Amount of ore in the mine
The optionality:
The value of the option to decide whether to proceed to construction, or alternatively
walk away, after the drilling results are known rather than before
The strike price:
Cost of developing the mine
The underlying asset:
The developed mine
8. List, and briefly explain, the three main reasons that the firm that wins the auction in the
Antamina case may choose to lease, rather than buy, the equipment used to operate the mine.
The leasing company may be expected to be able to make better use of the depreciation
tax shields than the miner.
Leasing may provider lower cost financing than debt because of the lower cost of default
to leasing company than a bank.
The mining firm may need to shut down the mine, in which case it will exercise an option
to return equipment to the lessor.
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9. Consider a fast growing retailer like JBHI (JB Hi Fi). List and briefly explain how the nature
of the balance sheet of the firm (asset ownership and financing characteristics) allows the
firm to grow so quickly.
Inventory is the largest part of assets and inventory is completely financed by trade credit
reducing the NWC and hence the part of current assets that must be financed with long
term capital.
Shops are leased rather than rented; increasing the assets/sales ratio.
Debt is about 1/3 of book equity
10. Imagine that Vicksburg hedge fund decides to speculate on the price of BHP oil price by
selling a call option on oil with a strike price of $100 per barrel and buying a put option on oil
with a strike price of $60. Draw a diagram with the pay-off at maturity (per barrel) of that
combination of put and call positions on the Y-axis and the price of oil at maturity on the X-
axis.
Pay-offT
Long
put
$100
$60 ST
Short
call
11. Imagine that you are on the T-bond futures arbitrage desk of an investment bank. You can
either borrow $100 million in cash for up to 6 months or short T-bonds with market value of
$100 million but not both. The cost of shorting the bonds for six months is 0.05% of value
paid in advance. The spot price of 10 year T-bonds is 100.73 (percent of their face value).
The six month futures price of bonds is 100.12. The bonds have a coupon rate of 4.35% and
the next coupon will be received three months from today. If 3 month Libor is 2.25% and 6
month Libor is 3.25% then what is the maximum arbitrage profit that you can make from this
opportunity.
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CS = Cost of short = 0.05
100 0.0435
.100.e = 2.147
0.0225 . 0.25
I =
100.73 2
Test whether the futures price is below the lower arbitrge bound

F0 = 100.120 < 100.147 = 100.73 2.147 0.05 .e
0.0325 . 0.5
r
= S0 I CS .e 0.5
.T
Arbitrage is to short bonds, lend out proceeds, long futures contract

Profit = 100.147 - 100.120 .e = $0.0267 million or $26,700
0.0325 . 0.5
12. The price of BHP shares is $50. The 6 month risk free rate is 5%. If at-the-money BHP call
options with six months to expiry are selling for $2.45, then what is the price of at-the-money
BHP put options with six months to expiry? Ignore dividends
0.05. 0.5
Put call parity: p = C + K.e rT - S = 2.45 + 50.e - 50 = $1.22
13. On average the customers of the Boro Inc pay invoices 48 days after the sale date. The
company decides to introduce a discount of 2 percent for customers who pay after 10 days. It
is expected that early payers and later payers are equally likely to take the discount. What
does the discount imply about Boros cost of capital tied up in financing receivables?
365

100 38
Implied CoC = 1 = 0.214 or 21.4%
98
14. Aldo borrows 2,000,000 Qantas shares and sells them for $2.51 per share. Qantas pays a
dividend of $0.08 after 2 months and Aldo buys the shares back for $2.38 after 6 months. At
what APR has he effectively borrowed money over the 6 months?
0.08 2.38
2.51 = 1
+ 3
APR APR
1 6 1 6
Using the excel IRR function gives: APR = -0.041 or -4.1%
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15. The Lepanto Company has $100 million of cash, $30 million of which is operating cash.
The firm decides to use the excess cash plus the $80 million of a private placement of debt to
buy back shares in the firm. The current share price is $14 and the buyback will take place at
$15 per share. The effective corporate tax rate of the firm is 15%.
Calculate the total present value of tax shields in the buy back.
Excess cash = 100 - 30 = 70
Change in debt = Excess cash used + new debt = 70 + 80 = 150
PV Tax shields = D.TC = 150 . 0.15 = $22.5 million
What proportion of the present value of tax shields (in percent) will go to the
shareholders who remain after the buyback?
buy-back total 150

# of shares repurchased = = = 10 million
buy back price 15
Debt shield value to share sellers
= buy-back premium . buy-back volume = $10 million
10
% of value to share sellers = 44.4%
22.5
% of value to remaining shareholdes = 1 44.4% = 55.6%
16. Sylvan Inc paid 8.5 times FCF for Pectuk Inc. Sylvan expects the FCF of Pectuk to grow at
6% in perpetuity. What is Sylvans required return on capital in the purchase?
FCF 1 1
TEV = ; Therefore, = 8.5; r = + 0.06 = 0.178 or 17.8%
rg rg 8.5
17. The Trebia Company is comparing the cost of buying rather than leasing machine tools. The
price to buy the equipment is $5.2 million. Purchased equipment can be depreciated straight-
line at 25% per year. Alternatively, a lease would have payments of $1.25 million per year,
with the first payment today. Trebia has an effective corporate tax rate of 30% and is
expecting to pay taxes that are large compared to this lease deal. Taxes will be paid at the
end of each year going forward. If Trebia after-tax cost of equity capital is 12%, then should
Trebia lease or purchase?
Leasing is less expensive PV(lease payments) < PV(purchase cashflows) as shown below
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TC 0.3
Lease Buy
Time DF L L after tax DCF Price Dep tax shield DCF
0 1.00 1.25 0 1.25 5.2 0 5.2
1 0.90 1.25 -0.375 0.79 0 -0.39 -0.35
2 0.81 1.25 -0.375 0.71 0 -0.39 -0.32
3 0.73 1.25 -0.375 0.64 0 -0.39 -0.29
4 0.66 1.25 -0.375 0.58 0 -0.39 -0.26
5 0.59 0 -0.375 -0.22 0 0 0.00
3.74 3.99
18.
19. The Orantes Corporation is conducting financial planning. The firm cannot raise any new
debt or issue any new shares. All growth must be financed by retained earnings. The firm
has $100 million of debt and $200 million of equity. It cuts dividends to 30% of net income.
Sales per dollar of net assets are increased to $2. What net margin must the firm attain if it
wishes to grow sales at 20% per year?
Since no outside capital can be raised the maximum growth rate of the firm
is the internal growth rate (IGR)
Retained earnings R.E NI Sales

IGR = = . .
Net assets NI Sales Net assets
0.20 = 0.70 . net margin . 2

Required net margin = 0.143 or 14.3 %
Use the following table to answer questions 19 and 20

0.5 5.15
1.0 5.60
1.5 5.95
2.0 6.20
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2.5 6.35
3.0 6.45
20. Consider a 7 year fixed for floating interest rate swap with a notional value of $100 million
that was opened on 20 August 2006. On each 20 August or 20 February payment date the
fixed party receives $3.61 million and the floating party receives 6 month Libor (set six
months earlier). If 6 month Libor was 5.35% on 20 February 2010, then what is the value of
the swap to the party paying floating on 20 August 2010?
VFloating = 100 because a coupon payment has just been made
VFixed 3.61 .e + 3.61 .e + . . . + 3.61 .e + 103.61 .e

0.0515. 0.5 0.0560.1 0.0635. 2.5 0.0645. 3.0
96.49
Vswap = VFixed - VFloating = 101.8 - 100 = $1.88 million
21. Calculate the swap rate on new 3 year fixed for floating rate swaps opened on 20 August
2010.
C 0.0515. 0.5 C 0.0560.1 C 0.0645. 3

100 = .e + .e +. . .+ 100 + .e
2 2 2
C =

2.100. 1 - e0.0645. 3 = 0.0652 or 6.52%
e 0.0515. 0.5
+e
0.0560.1
+. . .+e
0.0645. 3

21 of 27
Corporate Finance Practice Final Exam II

Solution
3 hours
Note: This is not intended to be a model exam solution. Some of the

answers given here contain more information than was required for a full
grade. A model exam would have shorter answers than given here.
a. Customers with higher switching costs have lower value to a bank. False
b. Factoring, or vendor financing, is a source of liquidity for firms. True
c. If a firm uses excess cash to buy back its own shares then the firms required return on
equity increases. True
d. Investors demand a liquidity premium that is approximately the round trip cost of buying
and then selling the asset, divided by the expected length of time the asset will be held.
True
e. In terms of sensitivity to interest rate changes the position of paying fixed in a fixed-for-
floating interest rate swap has negative duration. True
a. The trade-off theory of capital structure says that firms do not have a target level of
leverage, but instead the level of leverage results from other decisions. False
b. Firms give all customers the same trade credit terms. False
c. Prinicipal is exchanged in currency swaps but not in interest rate swaps. True
d. When the volatility of the underlying asset increases a call option on the asset increases in
value and a put option decreases in value. False
e. The margin account of the long party falls when the futures price falls. False
22 of 27
3. Four types of participants in the oil futures market are shown below. Beside each bullet
point, in one short sentence, give one reason why that participant might take the short position
in an oil futures contract.
Hedger: To hedge the risk that a falling oil price reduces revenue on future production.
Speculator: To. profit from expected fall in oil prices
Market maker: To take the off-setting position to a long contract
Arbitrageur: To arbitrage a futures price that is too high relative to the spot price
4. Give one example of each of the following

Contracting cost of financial distress: Vendor demanding better terms because of the
risk it will lose its firm specific investment
Loss of asset value in financial distress: Destruction of intellectual property in a biotech
firm that approaches financial distress.
Lost opportunity cost of having high leverage: Firm that is unable to buy in a fire sale
of assets by a competitor
5. Explain how private, family owned firms differ from large listed firms in the following areas
of financial policy:
Leverage: Lower -- Family firms generally have lower leverage because their lower
diversification makes them more risk averse.
Cost of capital: Higher -- Lower leverage makes the WACC higher. And, the low
diversification of the familys wealth raises the cost of equity capital used in the firm.
6. Imagine that the St Barbara gold mining firm hedges the annual production from one of its
mines by buying an option to put gold at $1100 per oz and selling an option to buy gold at
$1300 per oz. Draw a diagram with the pay-off at maturity (per oz) of that combination of
put and call positions on the Y-axis and the price of gold on the X-axis.
Pay-offT
Long
Put
1300
1100 ST
Short
call
23 of 27
7. Explain, in just one or two sentences, two conflicts of interest that arise between shareholders
and debt holders when a firm approaches financial distress.
Shareholders gain and debt holders lose from an increase in the volatility of asset value.
Shareholders may chose not to take a positive NPV project that would add value for
bondholders.
8. Consider the equation for the present value of debt shields: PV(debt shields) = D.T C
Explain how this equation is derived.
rD .TC .D r .T .D r .T .D
PV of tax shields = + D C 2 + D C 3 + . . .
1 r 1 r 1 r
rD .TC .D
= = TC .D
r
rD Interest rate on the debt
TC = The effective corporate tax rate
D = $ value of debt which is rolled over in perpetuity
r = rD because the risk of default to the debtholder is the same risk
of non-usage of debt shields to the shareholders
9. In what sense is trade credit the provision of liquidity?

Trade credit reduces the net working capital requirements of firms and reduces their need
to store liquidity on the balance sheet in the form of cash or excess liquidity through a
bank lines of credit.
Every form of short term credit is a form of liquidity provision. Trade credit is lending
for 30, 60 or 90 days.
10. Why does Qantas hedge more oil price risk than VirginBlue
The cost financial distress is higher for Qantas because it would damage or destroy their
frequent flyer business and / or their business travel monopoly in Australia.
VirginBlue is a discount airline that would not suffer such great asset value loss in
financial distress.
24 of 27
11. The Westphalia company offers its customers 90 days trade credit. Westphalia offers a
discount of 5% if customers pay within 15 days of purchase. What does the discount imply
about Westphalias cost of capital in financing receivables. Assume that all customers either
pay on the 15th day or on the 90th day.
365

100 75
r = - 1 = 0.284 or 28.4%
95
12. The price of wheat today is $230 per tonne. The cost of storing wheat for one year (payment
in advance) is $25 per tonne and the 1 year Libor rate is 5.25 percent. What is the upper
bound on the futures price of wheat? (The price level beyond which there is an arbitrage
opportunity).
F0 < S0 U .erT = 230 25.e0.0525.1 = $268.74
13. The price of BHP shares is $45 and one year Libor is 5.25 percent. Consider puts and calls
on BHP shares with one year to maturity. At what strike does the price of a put equal the
price of a call.
Put call parity: c - p = S - K.e rT
c-p = 0 S = K.e rT K = S.e rT = $47.43
14. The total enterprise value of a firm is 6 times free cash flow (FCF), where FCF is received
one year from today. If FCF is expected to grow at 5% in perpetuity then what rate are the
cashflows being discounted at to give a TEV multiple of six.
1 1
6 = ; r = + 0.05 = 0.217 = 21.7%
r 0.05 6
15. Fei River is the holding company of a foreign subsidiary named Yarmouk. Fei River is
leveraged to 0.4 with 6.5% debt. The required return on the assets of the subsidiary is 25%.
Yarmouk is geared to 0.3 with 9.2% debt, and has an effective corporate tax rate of 0.20. If
Fei River has an effective corporate tax rate of 30%, then what is its WACC?
25 of 27
Yarmouk :
D D
= 0.3 = 0.43
E + D E
D
rEL = rEU + . 1- TC . rEU - rD
E
= 0.25 + 0.43 . 1- 0.20 . 0.25 - 0.092 = 0.304
Fei River :
D
rEL = rEU + . 1- TC . rEU - rD
E
The required return on equity of the subsidiary is the required return on
assets of the parent
= 0.304 + 0.4 . 1- 0.30 . 0.304 - 0.065 = 0.371
16. Wally borrows 1000 Westpac shares and sells them for $25,450. After 2 months Westpac
pays a dividend of $0.81. Wally buys back the shares after 3 months for $27,250. At what
annual rate has Wally borrowed money over the 3 months?
0.81 27.25
25.45 = 2
+ 3
; r = 0.401 or 40.1%
r r
1 1
12 12
17. The Toures Corporation is conducting financial planning. The firm has net working capital of
$200 million, long term assets of $400 million and long term debt of $150 million. The net
margin is 4.5%, the plowback ratio is 70% and the firm has sales of $1.5 billion. What level
of asset utilization does the firm have to achieve to reach a sustainable a growth rate of 15%?
BE D
SGR = PB ratio x Profit margin x Asset util x
BE
0.70 x 0.045 x Asset util x

750 Sales
0.15 = Asset util = = 3.8
600 Net assets
18. The Monteverde company is expected to pay $17.5 million in interest payments and $80
million in dividends in perpetuity. The yield on the debt is 7% and the required return on the
equity is 10%. The effective corporate tax rate is 15%.
Calculate the WACC of the firm.
17.5 80
D = = 250; E = = 800
0.07 0.10
800 250
WACC = . 0.10 + . 1 0.15 . 0.07 = 0.090 or 9.0%
800 250 800 250
26 of 27
Then use the WACC to discount the cashflows from the firm to show that the TEV of the
firm is $1050 million.
80 + 17.5 . 0.85
TEV = = 1050
WACC

0.5 4.55
1.0 5.10
1.5 5.45
2.0 5.70
2.5 5.85
3.0 5.90
19. Consider a 3 year interest rate swap which is created on 11 August 2010. Fixed payments at
the swap rate are swapped for 6 month Libor twice per year. The notional value of the swap
is $100 million. Use the data in the table above to calculate the swap rate (annual percentage
rate of fixed rate payments).
C 0.0455. 0.5 C 0.0510.1 C 0.0590. 3

100 = .e + .e +. . .+ 100 + .e
2 2 2
C =

2.100. 1 - e0.0590. 3 = 0.0596 or 5.96%
e
0.0455. 0.5
+e
0.0510.1
+. . .+e
0.0590. 3

20. Continuing from the previous question. Calculate the present value of the floating rate
payment that will be made on 11 February 2012.
PV of coupon 100e 0.0510.1.0 -100e 0.0545.1.5
$2.88 million
27 of 27

111 Practice Final Exams

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111 Practice Final Exams

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Student Number ___________

Corporate Finance Practice Final Exam I

Hedge the interest rate risk with a swap contract

Hedge the currency risk with a swap contract

The price of the real option to develop the mine:

The main source of uncertainty:

The strike price:

The underlying asset:

Use the following table to answer questions 19 and 20.

Maturity Libor zero rate

Corporate Finance Practice Final Exam II

You have 3 hours to complete this exam

b. Factoring, or vendor financing, is a source of liquidity for firms.

b. Firms give all customers the same trade credit terms.

c. Prinicipal is exchanged in currency swaps but not in interest rate swaps.

4. Give one example of each of the following

Loss of asset value in financial distress:

Lost opportunity cost of having high leverage:

9. In what sense is trade credit the provision of liquidity?

Use the following table to answer questions 19 and 20.

Maturity Libor zero rate

Corporate Finance Practice Final Exam I

Note: This is not intended to be a model exam solution. Some of the

Hedge the interest rate risk with a swap contract

Hedge the currency risk with a swap contract

Cash held on the balance sheet

Bank lines of credit

Factoring or invoice financing

Hedger: To hedge the risk of fixed rate debt.

Speculator: To profit from rise in interest rates.

The price of the real option to develop the mine:

Debt is about 1/3 of book equity

CS = Cost of short = 0.05

Arbitrage is to short bonds, lend out proceeds, long futures contract

Using the excel IRR function gives: APR = -0.041 or -4.1%

PV Tax shields = D.TC = 150 . 0.15 = $22.5 million

buy-back total 150

Debt shield value to share sellers

= buy-back premium . buy-back volume = $10 million

is the internal growth rate (IGR)

Retained earnings R.E NI Sales

0.20 = 0.70 . net margin . 2

Use the following table to answer questions 19 and 20

Maturity Libor zero rate

VFloating = 100 because a coupon payment has just been made

VFixed 3.61 .e + 3.61 .e + . . . + 3.61 .e + 103.61 .e

Vswap = VFixed - VFloating = 101.8 - 100 = $1.88 million

C 0.0515. 0.5 C 0.0560.1 C 0.0645. 3

Corporate Finance Practice Final Exam II

Note: This is not intended to be a model exam solution. Some of the

4. Give one example of each of the following

rD Interest rate on the debt

TC = The effective corporate tax rate

D = $ value of debt which is rolled over in perpetuity

r = rD because the risk of default to the debtholder is the same risk

of non-usage of debt shields to the shareholders

9. In what sense is trade credit the provision of liquidity?

F0 < S0 U .erT = 230 25.e0.0525.1 = $268.74

Put call parity: c - p = S - K.e rT

c-p = 0 S = K.e rT K = S.e rT = $47.43

0.70 x 0.045 x Asset util x

Use the following table to answer questions 19 and 20.

Maturity Libor zero rate