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Midterm Sample 2014
Midterm Sample 2014
Midterm Sample 2014
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INSTRUCTIONS TO CANDIDATES
1. This examination paper contains THIRTY (30) multiple choice questions and
comprises SEVENTEEN (17) printed pages.
2. Tick clearly the most appropriate response on the answer sheets provided on pages 1
and 2. Only answers recorded on the answer sheet will be graded. There is only
ONE (1) correct answer for each question. No penalty for wrong answers.
3. The whole test paper will be collected at the end of the test.
5. You may use pages 15, 16 and 17 for your own workings.
Student Name:
A1 (Thursday AM)
A2 (Thursday PM)
A3 (Wednesday AM)
FIN3101A SEMESTER 2 2013/2014
Tick (√) the most appropriate answer. No penalty for wrong answers.
Question a b c d e
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Tick (√) the most appropriate answer. No penalty for wrong answers.
Question a b c d e
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1) You are considering the following two mutually exclusive projects that will not be repeated.
The required rate of return is 11.25% for project A and 10.75% for project B. Which project
should you accept and why?
Year Project A Project B
0 -$48,000 -$126,900
1 $18,400 $ 69,700
2 $31,300 $ 80,900
3 $11,700
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2) The IGA Co. is considering two mutually exclusive projects with the following cash flows. The
incremental IRR for the investing scenario is _____ and if the required rate is higher than this
crossover rate then project _____ should be accepted.
a. 15.44%; B
b. 15.86%; A
c. 13.94%; B
d. 15.44%; A
e. 13.94%; A
The crossover rate is 13.94%. At a rate higher than the crossover rate, such as 15%, Project B will have the
higher NPV and should be accepted.
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3) Changi Boats Ltd. currently produces boat sails and is considering expanding its operations to
include awnings for homes and travel trailers. The company owns land beside its current
manufacturing facility that could be used for the expansion. The company bought this land
ten years ago at a cost of $250,000. Today, the land is valued at $425,000. The grading and
excavation work necessary to build on the land will cost $15,000. The company currently
owns some unused equipment valued at $60,000. This equipment could be used for producing
awnings if $5,000 is spent for equipment modifications. Other equipment costing $780,000
will also be required. What is the amount of the initial cash flow for this expansion project?
a. $1,285,000
b. $1,110,000
c. $800,000
d. $1,050,000
e. $1,225,000
4) A project will produce operating cash flows of $45,000 a year for four years. At the start of
the project, inventory will be lowered by $30,000 and accounts receivable will increase by
$15,000. Accounts payable will decrease by $10,000. The project requires the purchase of
equipment at an initial cost of $120,000. The equipment will be depreciated straight-line to a
zero book value over the life of the project. The equipment will be salvaged at the end of the
project creating a $25,000 after-tax cash flow. At the end of the project, net working capital
will return to its normal level. What is the net present value of this project given a required
return of 14% and a tax rate of 17%?
a. $16,117.05
b. $49,876.02
c. $3,483.48
d. $27,958.66
e. $32,037.86
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6) What is the portfolio variance if 30% is invested in stock S and 70% is invested in stock T?
a. .098000
b. .008080
c. .004056
d. .002220
e. .006224
7) An unlevered firm has a cost of capital of 14% and earnings before interest and taxes of
$150,000. A levered firm with the same operations and assets has both a book value and a
face value of perpetual debt of $700,000 with a 7% annual coupon. The applicable tax rate is
35%. What is the value of the levered firm?
a. $696,429
b. $907,679
c. $941,429
d. $1,184,929
e. $1,396,429
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8) Emas Inc. has debt with both a face and a market value of $3,000. This debt has a coupon rate
of 7% and pays interest annually. The expected earnings before interest and taxes is $1,200,
the tax rate is 34%, and the unlevered cost of capital is 12%. What is the firm's cost of
equity?
a. 13.25%
b. 13.89%
c. 13.92%
d. 14.14%
e. 14.25%
9) TeamBuild Co. is planning to raise $2,500,000 in perpetual debt at 11% to finance part of
their expansion. They have just received an offer from a Sovereign Fund to raise the
financing for them at 8% if they build in Batam. What is the side effect of the debt financing
to TeamBuild if their tax rate is 34% and the Sovereign Fund raises it for them?
a. $850,000
b. $1,200,000
c. $1,300,000
d. $1,650,000
e. None of the above
10) Bunkers Marine, a company in the 40% tax bracket, has riskless debt in its capital structure
which makes up 30% of the total capital structure, and equity is the other 70%. The beta of
the assets for this business is .9 and the equity beta is:
a. 0.54
b. 0.90
c. 1.13
d. 1.20
e. 1.49
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Blue Bayou (BB) is a clothing retailer with a current share price of $10.00 and with 25 million
shares outstanding. It has no debt. Suppose that BB announces plans to borrow $100 million in
order to repurchase shares.
11) Assuming perfect capital markets, the share price for BB after this announcement is
a. $11.40
b. $10.85
c. $10.00
d. $8.60
e. $14.00
12) Suppose that BB pays corporate tax of 35% and that shareholders expect the change in debt to
be permanent. Assuming that capital markets are perfect except for the existence of corporate
taxes, the share price for BB immediately after this announcement is closest to:
a. $10.00
b. $10.85
c. $8.60
d. $11.40
e. $12.33
13) Suppose that BB pays corporate taxes of 35% and that shareholders expect the change in debt
to be permanent. Assume that capital markets are perfect except for the existence of
corporate taxes and financial distress costs. If the price of BB's stock rises to $10.85 per
share immediately following the announcement, then the present value of BB's financial
distress costs is closest to:
a. $21.25 million
b. $35.00 million
c. $11.40 million
d. $13.75 million
e. $22.20 million
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a. Firms with steady, reliable cash flows, such as utility companies, are able to use high
levels of debt and still have a very low probability of default.
b. If there were no costs of financial distress, the value of the firm would continue to
increase with increasing debt until the interest on the debt equals the firm’s earnings
before interest and taxes and the tax shield is exhausted.
c. The costs of financial distress reduce the value of the levered firm, VL. The amount of
? the reduction decreases with the probability of default, which in turn increases with the
level of the debt.
? d. The tradeoff theory states that firms should increase their leverage until it reaches the
level D* for which VL is maximized.
e. With higher costs of financial distress, it is optimal for the firm to choose lower leverage.
Greengate Industries is expected to generate free cash flows of $24 million per year. Greengate
has permanent debt of $80 million, a corporate tax rate of 40%, and an unlevered cost of capital
of 12% and its cost of debt capital is 6%.
15) The value of Greengate's equity using the APV method is closest to:
a. $72 million
b. $152 million
c. $180 million
d. $230 million
e. $42 million
$24 million
APV = VL = VU + TcD (40%)$80 million = $232 million
.12
Value of equity = total value - debt = $232 - $80 = $152 million
16) If Greengate's debt cost of capital is 6%, then Greengate's equity cost of capital is closest to:
a. 11.2%
b. 12.0%
c. 13.89%
d. 15.2%
e. 16.0%
$24 million
Using APV VL = VU + TcD (40%)$80 million = $232 million
.12
D 80
re = ru + (ru - rd)(1-T) = 12% + (12% - 6%)(1-0.4)= 13.8947%
E 232 80
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a. 6.0%
b. 9.5%
c. 10.3%
d. 10.7%
e. 11.2%
$24 million
Using APV = VL = VU + TcD (40%)$80 million = $232 million
.12
80
rwacc = ru - dTc[rd + ϕ(ru - rd)] where ϕ = 1 with permanent debt and d =
232
80
rwacc = (1-40%)[6%] + 152/232 (13.8947) =1.24 + 9.10=10.3434
232
The Dairy Co. is analyzing a proposed project. The company expects to sell 12,000 units, give or
take 4%. The expected variable cost per unit is $7 and the expected fixed cost is $36,000. The
fixed and variable cost estimates are considered accurate within a plus or minus 6% range. The
depreciation expense is $30,000. The tax rate is 34%. The sale price is estimated at $14 a unit,
give or take 5%.
18) What is the earnings before interest and taxes under the expected case scenario?
a. $18,000
b. $24,000
c. $36,000
d. $48,000
e. $54,000
EBIT for base case = [12,000 ($14 - $7)] - $36,000 - $30,000 = $18,000
19) What is the earnings before interest and taxes under the optimistic case scenario?
a. $22,694.40
b. $24,854.40
c. $37,497.60
d. $52,694.40
e. $67,947.60
EBIT for best case = (12,000 1.04) [($14 1.05) - ($7 .94)] – ($36,000 .94) - $30,000 =
$37,497.60
20) What is the earnings before interest and taxes under the pessimistic case scenario?
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a. -$566.02
b. -$422.40
c. -$278.78
d. $3,554.50
e. $5,385.60
EBIT for worst case = {[12,000 .96] [($14 .95) – ($7 1.06)] – ($36,000 1.06) - $30,000}
= -$422.40
21) Given the following information, calculate the present value break-even point.
Initial investment: $2,000
dk Fixed costs: $2,000 per year p-vc 14x
Variable costs: $6 per unit fc -2000
Depreciation: $500 per year depre- 500
Price: $20 per unit ebit 14x-2500
Discount rate: 10% eat .66(14x-2500
add depre +500
Project life: 4 years fcf 9.24x-1150
Tax rate: 34%
22) Highgate Incorporated is considering a project that has an initial cost today of $10,000. The
project has a two-year life with cash inflows of $6,500 a year. Should Highgate decide to wait
one year to commence this project, the initial cost will increase by 5% and the cash inflows
will increase to $7,500 a year. What is the value of the option to wait if the applicable
discount rate is 10%?
a. $1,006.76
b. $1,235.54
c. $1,509.28
d. $1,606.76
e. $1,735.54
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$6,500 $6,500
NPVt 0 $10,000 $10,000 $5,909.0909 $5,371.9008 $1,280.99
1.101 1.102
$7,500 $7,500
NPVt 1 ($10,000 1.05) $10,500 $6,818.1818 $6,198.3471 $2,516.5289
1.101 1.102
NPVt 0 $2,516.5289 1.10 $2,287.75
Value of option to wait = $2,287.75 - $1,280.99 = $1,006.76
23) Your firm is considering a project with a five-year life and an initial cost of $120,000.
The discount rate for the project is 12%. The firm expects to sell 2,100 units a
dk year. The cash flow per unit is $20. The firm will have the option to abandon this
project after three years at which time it expects it could sell the project for
$50,000. You are interested in knowing how the project will perform if the sales
forecast for years four and five of the project are revised such that there is a 50%
chance that the sales will be either 1,400 or 2,500 units a year. What is the net present
value of this project given your sales forecasts? sell or not sell(50k)
a. $23,617
b. $23,719
c. $25,002
d. $26,877
e. $28,746
Level to abandon =
1 [1 /(1 .12) 2 ]
$50,000 (Q $20) ;$50,000 33.801Q; Q 1,479 units ;
.12
At 1,400 units you will abandon the project and receive $50,000.
At 2,500 you will continue the project and the NPV will be:
1 [1 /(1 .12) 2 ]
NPV (2,500 $20) $50,000 1.6901 $84,505
.12
$50,000 $84,505
2,100 $20 2,100 $20 2,100 20 2
NPV $120,000 ;
1.121 1.122 1.123 1.123
NPV $120,000 $37,500 $33,482.1429 $29,894.7704 $47,869.0011 $28,746
a. causes the owner-manager to work less hard and shirk their duties as they have less
capital at risk.
b. causes the owner-manager to consume more perquisites because the cost is passed to the
debtholders.
c. causes both more shirking and perquisite consumption since the government provides a
tax shield on debt.
d. causes agency costs to fall as owner-managers do not need to worry about other
shareholders.
e. causes the owner-manager to reduce shirking and perquisite consumption as the excess
cash flow must be used to meet debt payments.
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25) The cum rights price of a stock is $20, the ex-rights price is $15, and the number of rights
needed to buy a new share is 2. What is the subscription price?
a. $5
b. $13
c. $17
d. $18
e. $20
(15-x)/2 = 5
x = $5
a. III only
b. III and IV only
c. I, III and IV only
d. II and IV only
e. I, II, III, and IV
27) Which of the following statements concerning the arbitrage pricing theory (APT) is correct?
a. the timing of the project’s cash flows has no bearing on the value of the project.
b. the project will always be accepted.
c. the project will always be rejected.
d. whether the project is accepted or rejected will depend on the timing of the cash flows.
e. the project can never add value for the shareholders.
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