Practice Final Exam

12/22/2020 Practice Final Exam: FL2020.B52.FIN.448.
02 & 03 - Advanced Financial Management
Practice Final Exam

Due No due date Points 100 Questions 9 Time Limit 180 Minutes
Allowed Attempts Unlimited
Instructions
FIN 448
Advanced Financial Management
PRACTICE FINAL EXAM
Take the Quiz Again
Attempt History
Attempt Time Score
LATEST Attempt 1 180 minutes 0 out of 100 *
* Some questions not yet graded
 Correct answers are hidden.
Submitted Dec 21 at 2:12am
Disclaimer: This practice final exam roughly resembles what the

upcoming exam will look like in terms of its format. It has been
designed to reflect mainly the materials that are related to our
course. However, this does not mean the practice exam will show
exactly the same length, difficulty, emphases, and weights on topics
we have covered so far for the upcoming exam.
Instructions:
1. The exam is open-book and open-notes. You are allowed to use the
textbook, lecture notes, homework solutions, and self-prepared notes.
Also feel free to use a calculator, laptop, or tablet if needed.
https://wustl.instructure.com/courses/45557/quizzes/44828 1/12
12/22/2020 Practice Final Exam: FL2020.B52.FIN.448.02 & 03 - Advanced Financial Management
Everyone must type (or write) his/her own answers to exam

questions.
2. Your work on this exam must represent your own effort and your
own effort only. Any form of collaboration including discussing exam
questions and sharing answers with anyone (both inside and outside
your class) is strictly prohibited during the exam. Copying the work
of others including from previous semesters or online will be
considered cheating.
3. You have three hours (180 minutes) to do the exam and submit your
answers/files in Canvas. There are 100 total points; points per
question are indicated next to the question.
4. Round percentages and values up to four (4) decimal places.
5. Whenever in doubt, please try to state your reasoning as clearly as
possible and, in particular, explain any additional assumptions you
may have used for obtaining your answers.
6. Read questions and instructions carefully, allocate your time wisely,
and all the best of luck!
Unanswered Question 1 Not yet graded / 0 pts
Please read the following important message before you start working on
the exam.
Students are required to abide by the Olin Business School Code of

Conduct. Academic dishonesty of any form will not be tolerated. Penalties
for academic offences such as plagiarism and cheating have ranged from
academic probation to expulsion from the school. Please type your name
in the box below to confirm your adherence to the Olin Honor Code. AN
EXAM WITHOUT A TYPED NAME WILL NOT BE GRADED.
Your Answer:
There are seven questions (Questions 2-8) in this exam. Please type
your answer in the text box provided underneath each question.
Unanswered
Question 2 Not yet graded / 15 pts
Recapitalization in Perfect Markets (15 points)
For this problem, ignore taxes, bankruptcy costs and any other market
frictions.
Olin Mfg. has assets that will produce total cash flow in one year (and
none thereafter) of either $200 million or $260 million, depending on the
state of the economy. Suppose that these outcomes are equally likely. The
firm is currently all-equity financed. Under their current all-equity financial
structure, the expected return on their equity (rE) is 15%.
Olin is considering changing capital structures by borrowing $50 million

and using the proceeds to repurchase equity. At this level of debt, the
interest rate on the debt will be 6%.
After this change in capital structure:
1. What will be the market value of the equity?

2. What will be the expected return to equityholders (rE)?
3. What will be the weighted average cost of capital?
Suppose that Olin subsequently decides to increase the debt issuance to

$75 million, still using all the proceeds to repurchase shares.
4. As a result of this higher debt level, we expect the weighted average

cost of capital to be:
(Choose one.)
A. Lower than in part 3
B. Same as in part 3
C. Higher than in part 3
5. As a result of this higher debt level, we anticipate the expected return

to equityholders (rE) will be:
(Choose one.)
A. Lower than in part 2
B. Same as in part 2
C. Higher than in part 2
6. As a result of this higher debt level, we expect the Price/Earnings ratio

to be:
(Choose one.)
A. Lower than with $50 million in debt
B. Same as with $50 million in debt
C. Higher than with $50 million in debt
Your Answer:
Unanswered
Debt vs. Equity Financing (15 points)
James is the sole owner of a firm that currently has no debt outstanding.
The firm has the following assets:
Assets in place that will generate perpetual total expected cash flow of
$4 million per year.
An investment opportunity of which investors are aware, but is not yet
funded. In order to take advantage of this opportunity, James needs to
raise $10 million in capital. Once implemented, the investment is
expected to generate perpetual total expected cash flow of $3 million
per year in the event of a major success or $1 million per year in the
event of a minor success. These two outcomes are equally likely.
The unlevered cost of capital for both projects is 10%.
Assume perfect capital markets for Parts 1-5.
1. Complete the market value balance sheet of James’ firm before the
capital is raised.
2. Complete the market value balance sheet of James’ firm after he
raises the capital by issuing $10 million of new equity.
3. What is James’ cost of equity after this $10 million of new equity is
raised in Part 2? And, how much is James’ equity stake worth after the
financing in this case?
4. Complete the market value balance sheet of James’ firm after he
raises the capital by issuing $10 million of bond with rD = 5%.
5. What is James’ cost of equity after this $10 million of bond is raised in
Part 4? And, how much is James’ equity stake worth after the
financing in this case?
Assume imperfect capital markets for Part 6.
6. If James were not operating in a perfect capital market, which

financing choice would:
(Choose one in each row.)
Minimize the riskiness of

Debt Equity No D
James’ equity?
Minimize the firm’s pre-tax

Debt Equity No D
WACC (rU)?
Minimize the firm’s after-tax

Debt Equity No D
WACC (rL)?
Minimize dilution at issuance

due to asymmetric Debt Equity No D
information?
Minimize James’ incentive to

contribute additional equity in
Debt Equity No D
the future to fund any new
projects that may arise?
Your Answer:
Unanswered
Tax-Bankruptcy Tradeoff (10 points)
Olin Industries currently has $600 million debt outstanding with an interest
rate of 5% and 50 million equity shares with a current price per share of
$20. Other information about the firm:
EBITDA = $195 million

Cost of equity rE = 10%
Cost of debt rD = 5%
Risk-free rate rf = 3%
Tax rates include:
Corporate tax rate c = 30%
Personal tax rate on interest income i = 35%
Personal tax rate on equity gains e = 15%
In the event of bankruptcy, you estimate that Olin will lose 20% of its
current firm value due to financial distress costs.
AAA AA A BBB
Annualized default rate 0.05% 0.10% 0.25% 0.50%
Average EBITDA/Interest
25.5 24.6 10.2 6.5
coverage ratio
The firm has just hired a new CFO, who is proposing to issue new equity
in order to pay off the debt (down to a zero balance). Investors previously
expected Olin to keep the $600 million in debt at a fixed level indefinitely.
Calculate the impact of the CFO’s new plan on Olin’s stock price.
Your Answer:
Unanswered
IPO (15 points)
Below is an excerpt from the recent IPO registration statement for King
Digital Entertainment:
Assume that the underwriter spread for this deal was 6% and the IPO
price was set at the mid-point of the anticipated range. Further assume
that the investment bank pre-sold all shares, including the over-allotted
shares, at the IPO price as usual.
1. Assume that after the stock started trading, the price rose to $26 per
share. What were the proceeds to the firm from this IPO?
2. Again, assume that after the stock started trading, the price rose to
$26 per share. What was the profit of the investment bank from
underwriting this IPO?
3. Now, assume that after the stock started trading, the price fell to $18
per share. Calculate the investment bank’s total profits from both
underwriter fees and trading profits.
4. As discussed in class, an IPO firm can use either the book-building
process or an auction for pricing and allocation of the IPO shares.
Give one reason that supports book-building and one reason that
supports auctions.
5. Consider selling a firm to the public via an IPO or to a private equity
firm through a leveraged buyout (LBO). Which transaction better
addresses each of the following market frictions?
Corporate taxes IPO
Information asymmetry IPO

Expected costs of financial distress IPO
Agency conflicts between managers and outside shareholders IPO
Agency conflicts between debtholders and equityholders IPO
Your Answer:
Debt and Payout Policy (15 points)
On April 10, Olin Industries announced they will issue $1 billion in new
debt at a 5% interest rate in order to fund a $10/share special dividend.
The ex-dividend date was April 27. After the transaction, Olin plans to
maintain their new D/V ratio perpetually going forward.
The following is information about Olin Industries before the transaction

(assume investors did not anticipate this announcement):
Shares outstanding = 100 million shares

Stock price = $56 per share
No debt
EBIT = $800 million
Corporate tax rate = 30%
EPS = $5.60 per share
rE = 10%
Expected growth = 1.5%
Ignore personal taxes and financial distress costs
1. What impact do you expect this transaction to have on Olin’s cost of

equity capital?
(Choose one.)
A. Olin’s cost of equity capital will increase.
B. Olin’s cost of equity capital will decrease.
C. Olin’s cost of equity capital will stay the same.
2. What do you expect the share price to be on April 28th, assuming no

other news relevant to the value of the firm comes out before then?
3. Suppose Olin uses the proceeds of the debt issuance to repurchase

shares rather than pay a special dividend. What do you expect the
share price to be on April 28th in this case? Assume the entire
repurchase is completed prior to the 28th.
4. Assume again that Olin uses the proceeds of the debt issuance to
repurchase shares. What will be Olin’s expected earnings per share
after the transaction?
5. You observe the following tax rates for two different countries:
Country A Country B
Corporate 35% 35%
Personal – interest 30% 35%
Personal – dividends 20% 35%
Personal – capital gains 15% 35%
Answer questions in the following table.

Which country’s tax code favors

Country A Country B
debt financing more?
Which country’s tax code favors a

Country A Country B
high payout level more?
In which country would you Country A Country B
expect to see a larger drop in the

share price (per dollar of dividend
paid) on the ex-dividend date?
Your Answer:
Risk Shifting and Debt Structure (15 points)
HighFly, Inc. owes $4,700 to its lenders at the end of the year. In its
current business as a traditional print shop, HighFly’s value will be $5,000
at the time when its debt is due. However, the firm has access to a new
technology that will allow its business to switch to smartphone design.
With the switch, the firm will be worth either $9,000 with a probability of
15% or $2,000 with a probability of 85%, depending on the
implementation of the technology and the intensity of the competition in
the smartphone market.
1. If HighFly were an unlevered firm, would it stay as a print shop or

switch to the smartphone design business? Show why.
2. If the $4,700 debt obligation is straight debt, would HighFly stay as a
print shop or switch to the smartphone design business? Assume that
equityholders control the investment decisions. Again show why.
3. If the $4,700 debt obligation is convertible debt (convertible into 80%
of the firm’s shares at the debtholders’ option), would HighFly stay as
a print shop or switch to the smartphone design business? Again
assume that equityholders control the investment decisions. Also,
show why.
4. Explain briefly why the firm makes different decisions as we change
the debt structure from Part 1 to Part 2, then to Part 3?
Your Answer:

Valuation of Leveraged Buyout (15 points)
The table below contains projected operating results for the 2005
leveraged buyout of Toys R Us by a private equity consortium consisting
of KKR, Bain Capital, and Vornado Realty Trust. The shaded cells are
currently empty and need to be filled in first to answer the questions.
You are working as an analyst for the private equity group to evaluate the
potential deal. Use the following assumptions to answer the questions
below:
The total purchase price of $8 billion is funded with $6.7 billion in total
debt and the remaining $1.3 billion in equity.
The interest rate on the debt is 8%.
The private equity group plans to exit the investment in 2010 and
estimates it will be able to sell at an Enterprise Value / EBITDA
multiple of 9.0 (similar to the current industry average).
They will use all available cash flow prior to exit to pay down debt each
year.
The firm will have $1.25 billion in cash, which is expected to remain
constant through the investment horizon.
The corporate tax rate is 35%.
Assume the deal closed at the end of fiscal 2005.
The unlevered asset beta for Toys R Us is 0.85.
At the proposed capital structure, the debt beta would be 0.3.
Risk-free rate (rf) = 4% and market risk premium (rm – rf) is 6%.
1. Calculate the IRR of the investment from the private equity group’s
perspective.
2. Will the private equity group be willing to make the investment given
these assumptions? [Hints: Compare the IRR of this investment for the
private equity group and to the appropriate hurdle rate.]
3. Suppose that due to regulatory concerns, banks were unwilling to lend
more than $5 billion to fund the deal, but the total purchase price
remains $8 billion. How would this affect the private equity group’s
estimated IRR and investment decision?
Your Answer:
Unanswered
Please use the space below to upload any files or images you may have
for any questions.
Your Answer:

Practice Final Exam - FL2020.B52.FIN.448.02 & 03 - Advanced Financial Management

Uploaded by

Copyright:

Available Formats

You might also like

Practice Final Exam - FL2020.B52.FIN.448.02 & 03 - Advanced Financial Management

Uploaded by

Document Information

Original Description:

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Practice Final Exam - FL2020.B52.FIN.448.02 & 03 - Advanced Financial Management

Uploaded by

Copyright:

Available Formats

12/22/2020 Practice Final Exam: FL2020.B52.FIN.448.

02 & 03 - Advanced Financial Management

Take the Quiz Again

* Some questions not yet graded

 Correct answers are hidden.

Submitted Dec 21 at 2:12am

Disclaimer: This practice final exam roughly resembles what the

Everyone must type (or write) his/her own answers to exam

Unanswered Question 1 Not yet graded / 0 pts

Students are required to abide by the Olin Business School Code of

Recapitalization in Perfect Markets (15 points)

Olin is considering changing capital structures by borrowing $50 million

After this change in capital structure:

1. What will be the market value of the equity?

Suppose that Olin subsequently decides to increase the debt issuance to

4. As a result of this higher debt level, we expect the weighted average

5. As a result of this higher debt level, we anticipate the expected return

6. As a result of this higher debt level, we expect the Price/Earnings ratio

Debt vs. Equity Financing (15 points)

The firm has the following assets:

The unlevered cost of capital for both projects is 10%.

Assume perfect capital markets for Parts 1-5.

Assume imperfect capital markets for Part 6.

6. If James were not operating in a perfect capital market, which

Minimize the riskiness of

Minimize the firm’s pre-tax

Minimize the firm’s after-tax

Minimize dilution at issuance

Minimize James’ incentive to

Tax-Bankruptcy Tradeoff (10 points)

EBITDA = $195 million

Annualized default rate 0.05% 0.10% 0.25% 0.50%

IPO (15 points)

Corporate taxes IPO

Information asymmetry IPO

Expected costs of financial distress IPO

Agency conflicts between managers and outside shareholders IPO

Agency conflicts between debtholders and equityholders IPO

Unanswered Question 6 Not yet graded / 15 pts

Debt and Payout Policy (15 points)

The following is information about Olin Industries before the transaction

Shares outstanding = 100 million shares

1. What impact do you expect this transaction to have on Olin’s cost of

2. What do you expect the share price to be on April 28th, assuming no

3. Suppose Olin uses the proceeds of the debt issuance to repurchase

Corporate 35% 35%

Personal – interest 30% 35%

Personal – dividends 20% 35%

Personal – capital gains 15% 35%

Answer questions in the following table.

Which country’s tax code favors

Which country’s tax code favors a

In which country would you Country A Country B

expect to see a larger drop in the

Unanswered Question 7 Not yet graded / 15 pts

Risk Shifting and Debt Structure (15 points)