National University of Modern Languages

Corporate Finance-Spring 2021

M.Com-III-IV (Morning)
Final Term Exam
Maximum Marks: 30 Maximum Time Allowed: 2 hours
Instructions
 Attempt all questions.
 Write down your roll # and class on the question paper.
 Attach the first title page format as provided by the University
 Mention the serial number of the pages on your answer sheets.
 Submit the snapshots of your handwritten answer sheets on Google classroom with your roll number and
class as a file name.

Q 1. Total Marks: (08)

(a) The two companies U and L belong to an equivalent risk class. These two firms are identical
in every respect except that U Company is unlevered while Company L has 20% debentures of
700,000. EBIT of both firms are 650,000. The equity capitalization rate for U is 10% and for L is
15% respectively. Calculate the cost of capital and value for each firm? (4 marks)

(b) A small construction project costs Rs.35000 and is expected to generate cash inflows as
Year Cash in flows($)
1 15,000
2 10,000
3 9,000
4 8,000
5 7,000
The cost of capital is 12 %.
Required:
a. Compute the Discounted payback period of the project (marks 2)
b. Compute the profitability index of the project (marks 1)
c. Based on the above capital budgeting techniques, should the company opt for the
project? Give reasons and interpretation of above results (marks 1)

Q 2. Choose the right option:

Total Marks: (1*03)+02
I. __________ Lease refers to a short-term lease that is often cancelable. For example,
a lease for office space represents this type of lease where the lease life is less than the
useful life of the asset.
a) A financial
b) An operating
c) A net
d) None of the above answers are correct.

II. The type of lease that includes a third party, a lender, is called a(n):
a) Sale and leaseback.
b) Direct leasing arrangement.
c) Leveraged lease.
d) Operating lease
III. A way to analyze whether debt or lease financing would be preferable is to:

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 a) Compare the net present values under each alternative, using the cost of capital as
the discount rate.
b) Compare the net present values under each alternative, using the after-tax cost of
borrowing as the discount rate.
c) Compare the payback periods for each alternative.
d) Compare the effective interest costs involved for each alternative.

IV. A firm is considering three different financing alternatives -- debt, preferred stock,
and common equity. The firm has created an EBIT-EPS chart that shows several
indifference points. What does each indifference point show the firm?

a) The level of EBIT that generates identical EPS under two alternative financing
plans.
b) The level of sales that generates identical EBIT and EPS figures.
c) It shows the level of EBIT and EPS at which Degree of Financial Leverage is
identical under two alternative financing plans.
d) None of the above.

Q 3. The Wildcat Oil Company is trying to decide whether to lease or buy a new computer-
assisted drilling system for its oil exploration business. Management has decided that it must
use the system to stay competitive; it will provide $2.7 million in annual pretax cost savings
for 5years. The system costs $9.4 million and will be depreciated straight-line to zero over
five years. Wildcat’s tax rate is 23 percent and the firm can borrow at 9 percent.

On the other hand, Lambert Leasing Company has offered to lease the drilling equipment to
Wildcat for payments of $2.05 million per year. Lambert’s policy is to require its lessees to
make yearly payments.

Required: Find out the net cash flows (hint: incorporating the tax benefits of depreciation or
lease payments) leasing over buying and suggest Wildcat whether it should lease or buy?
Total Marks: (04)

Q 4. Total Marks: (08)

(a) Shannon Corporation is considering acquiring Dalton Company for $ 100,000 in cash.
Dalton's cost of capital is 16%. Based on market analysis, a targeted cost of capital for Dalton is
12%. Shannon has estimated that Dalton can generate $ 9,000 of free cash flows over the next 6
years (Hint: The annuity of cash flows may be used). Using Net Present Value, should Shannon
acquire Dalton? (4 marks)

(b) On Tuesday, December 8, Hometown Power Co.’s board of directors declares a dividend of
75 cents per share payable on Wednesday, January 17, to shareholders of record as of
Wednesday, January 3. When is the ex-dividend date? If a shareholder buys stock before that
date, who gets the dividends on those shares: the buyer or the seller? Hint: January 1 is the holiday
for new year. (4 marks)

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Q 5. Total Marks: (05)
A telecommunication company Airtel Communication is seeking Greenland Entertainment
for a merger deal. The comparative financial data of both the companies at particular
instance of time is summarized as follows;

Airtel Communication Greenland Entertainment

Present earnings $50,000,000 $10,000,000
Shares outstanding 5,000,000 2,000,000
Earnings per share 10 5
Stock price 160 60

Based on the valuation of Greenland, Airtel Communications has determined that it is willing
to offer $70 per share for Greenland. This includes a premium above the pre-merger market
price of Greenland.
a. Determine the exchange ratio in terms of Airtel shares.
b. Calculate the total number of shares by using exchange ratio that Airtel Communication
has to offer to complete a bid for 100% of Greenland Entertainment?
c. Find the post-merger EPS for Airtel Communication @ $70 per share offer whether it
increases or decreases after merger?
d. Calculate the highest price paid without dilution of EPS for the acquirer?

GOOD LUCK

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