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Finance Cheat Sheet

Corporate Finance 2 (University of Lethbridge)

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MGT3470 Corporate Finance, Practice Exam (Part I)

1. The designated source(s) of external financing required to make the pro forma balance sheet balance
is called the
B) Plug variable

2. Why is it important to determine if a firm is operating at full capacity or not?

C) Because a firm with excess capacity has some room to expand sales without increasing the
investment in fixed assets.

3. Diversifiable risk is the risk that:

C) Is caused by an event that affects only a limited number of assets.

4. Over the past 50 years, which of the following investments has provided the smallest average risk
premium?
C) Treasury bills.

5. One year ago, Yoko purchased 100 shares of stock for $3,896. Since that time, he has received a total of
$180 in dividends. If he sells the stock at today's market price he will realize a total return on his investment
of 10.37%. Assuming he sells the stock today, what is the dollar amount of his capital gain per share of
stock?
B) 2.24

6. Your firm is considering a project which requires an initial investment of $5 million. Your target D/E ratio
is 0.67. Flotation costs for equity are 8% and flotation costs for debt are 2%. What is the true cost (in
dollars) of the project when you consider flotation costs?
C) $5.30 million

7. An unlevered firm has 10,000 shares outstanding. The firm can borrow $40,000 at 6% to buyback half of
its shares without altering existing share price. What is the firm’s break-even EBIT if there are no
corporate or personal taxes?
D) $4,800

8. Which of the following is true about the WACC?

A) The optimal capital structure is the one that maximizes the WACC.
B) The value of the firm will be maximized when the WACC is minimized.
C) The WACC is the appropriate discount rate for all new projects of the firm.
D) The WACC is impossible to calculate for a firm with multiple divisions.
E) Since discount rates and firm value move in the same direction, minimizing the WACC
will minimize the value of the firm.

9. Which of the following statements is/are true regarding corporate borrowing when EBIT is positive?
A) Increasing financial leverage increases the sensitivity of EPS and ROE to changes in EBIT.
B) Increasing financial leverage decreases the sensitivity of EPS and ROE to changes in EBIT.
C) Leverage is favourable when EBIT is relatively low and unfavourable when EBIT is relatively high.
D) Leverage is favourable when EPS is relatively high and unfavourable when EPS is relatively low.
E) High leverage decreases the returns to shareholders (as measured by ROE).

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10. ABC Company’s debt/equity=0, its cost of equity is 10.8% and it can borrow at 8%. If there are no taxes,
what will be the cost of equity if ABC changes its debt/equity to 0.5?
C) 12.2%

Section II: Short-answer / Calculation Questions

Question #1
Part 1.A

ABC Limited (ABC) is a boutique men’s fashion house, specializing in affordable fashion-forward separates,
with its own production facility. ABC is a growing firm and its financial managers predict that it will
need external financing to fuel its growth. The company’s most recent financial statements are provided
below. Using the percentage of sales approach, construct ABC’s 2014 Pro Forma Balance Sheet based
on the following information. How much is ABC’s external financial need (EFN)?

i. The company is operating at 100% capacity;

ii. The forecasted growth in sales is 18% for 2014;
iii. The firm has a dividend policy to pay out 30% of Net Income to its shareholders as cash dividends,
and keep the remaining 70% as retained earnings;
Year 2013 % of Sales
Sales 74,889 100.0%
Costs excluding Depreciation - 58,413 -78.0%
EBITDA 16,476
Depreciation - 5,492 -7.3%
EBIT 10,984
Interest Expense - 306
Pretax Income 10,678
Income Tax (35%) - 3,737
Net Income 6,941

Year 2013 % of Sales

Cash and Equivalents 11,982 16.0%
Accounts Receivable 14,229 19.0%
Inventories 14,978 20.0%
Total Current Assets 41,189 55.0%
PP&E 49,427 66.0%
Total Assets 90,616
Accounts Payable 11,982 16.0%
Long-term Debt 4,500
Total Liabilities 16,482
Stockholders' Equity 74,134
Total Liabilities & Equity 90,616

This is the same as the BJI example used in Week 4 Lecture.

Total Assets (funds needed) = $106,927

Total Liabilities & Shareholders’ Equity (funds available) = $98,531
EFN = $106,927 - $98,531 = $8,396
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Part 1.B

Discuss why it is important for managers to understand the importance of both the internal growth rate
and the sustainable rate of growth?
One reason that causes firms to go out of business is the lack of sufficient external funding to support
the growth of the firm.
Too much growth may not be supported by available external funding and, in turn, may hurt the
firm. Internal growth rate (IGR) is the maximum growth without any external funding, while sustainable
growth rate (SGR) is the maximum growth sustainable with only additional debt funding (equity naturally
rises because of retained earnings).
Understanding the implications of both the IGR and SGR rates can help management know when to limit
firm growth such that the growth does not exceed the available necessary financing to fund that growth.
When a firm is growing too fast, it will likely run into financial trouble in the future.
Question #2

Part 2.A

What is the expected rate of return for a portfolio that is comprised of $90,000 invested in stock S
and $60,000 in stock T?

E(r)Boom = [$90,000/($90,000 + $60,000) *0.11)] + [$60,000/($90,000 + $60,000) *0.05)

= 0.066 + 0.02 = 0.086
E(r)Normal = [$90,000/($90,000 + $60,000) *0.08)] + [$60,000/($90,000 + $60,000) *0.06)
= 0 .048 +0 .024 =0 .072
E(r)Bust =[$90,000/($90,000 + $60,000) * -0.05)] + [$60,000/($90,000 + $06,000) *0.08)
= -0.03 + 0.032 =0 .002
E(r)Portfolio = (0.05 *0.086) + (0.85 *0.072) + (0.10 *0.002) = 0.0043 + 0.0612 + 0.0002
= 0.0657 = 6.57%

Part 2.B

You have a $15,000 portfolio which is invested in stocks A and B plus a risk-free asset. $3,000 is
invested in stock A. Stock A has a beta of 1.7 and stock B has a beta of 1.3. Approximately how much
(in dollar terms) needs to be invested in stock B if you want your portfolio’s beta to equal that of
the overall market?

Portfolio Beta = weighted average sum of betas. Risk-free asset’s beta = 0.0, and market beta = 1.0.
Beta, portfolio = 1.0 = (3000/15000)*1.7 + (x/15000)*1.3 + ((15000 – 3000 - x)/15000)*0.0

15000 = 5100 + 1.3x =  x = (15000 – 5100) / 1.3 = $7,615.38

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MGT3470 Corporate Finance, Practice Exam (Part II)

1. Which of the following tend to keep dividends low?
I. Flotation costs
II. Uncertainty resolution
III. Restrictive terms contained in the company’s bank loan agreements
IV. The company’s desire to maintain constant dividends over time
Answer: I, III, and IV only

2. Chase Jewelry has a risk profile that shows the firm adding value when sudden price fluctuations of
gold move downward and losing value when gold price moves upward. If the company hedged its
financial risk by purchasing an option contract on gold, then the company would most likely ______
value when gold prices rose and ______ value when prices fell?
D) maintain; add

3. You buy 20 wheat futures contracts when the futures price is $3.52 per bushel (each contract is for
5,000 bushels). The actual wheat price on the maturity date is $3.12. What is your total profit/loss?
B) -$40,000

4. Which of the following statements are correct?

I. The usage of forward rates can help reduce the short-run exposure to exchange rate risk.
II. Political risk refers to changes in value that arise as a consequence of political actions in the country
where the firm has operations, and political risk cannot be hedged.
III. The short-run exchange rate risk faced by an international firm should be reduced by borrowing
money in the foreign country where the firm has operations.
IV. Unexpected changes in economic conditions are classified as long-run exposure to exchange rate risk.
Answer: I and V only

5. Suppose Bluejay Limited purchases Redline Enterprises for $118 million in cash. For purposes of the
acquisition, Redline's fixed assets were appraised at $85 million. Further, Redline Enterprises has
working capital of $13 million and no long-term debt. If Bluejay uses the purchase accounting
method to account for the acquisition, goodwill of ______ is created.
C) $20 million

6. A financial device designed to make unfriendly takeover attempts financially unappealing, if not
impossible, by giving target firm’s shareholders the rights to purchase shares in the merged
company at low price, is called:
D) Poison pill (Week 10 Slides — Slide 39)

7. Which of the following accurately completes the following statement: A tender offer:
D) Is followed up by a merger in many acquisitions.

8. Kojack Film needs silver to make photographic film. To ensure that they will have an ample supply of
silver at a reasonable price, the company purchases a silver mine. This is an example of a(n)
_______.
E) vertical acquisition

9. Generally speaking, if an acquiring firm offers the target firm cash for its stock, it will most likely
be a ______ acquisition; if the acquirer offers its own shares in return for the target firm's stock, it
will most likely be a _______acquisition.
B) taxable; tax-free
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10. In the early 1900s, the Standard Oil Company purchased many of its competitors in order to reduce
competition and increase its share of the domestic oil market. The firm's actions are consistent with
a strategy of making acquisitions to ________.
C. enhance revenues
Section II: Short-answer / Calculation Questions

Question #1
Part 1.A
In a particular year, you purchased 200 shares of XYZ stock on November 10th, and another 100
shares of XYZ on November 14th. You also bought 500 shares of TTT stock on December 3rd.
Dividends per share declared by these companies are tabulated below. Calculate and briefly
explain how much dividend income you will have received from these companies by the end of
December (ignoring taxes).
Company Name Dividend Record Date Monday, 17 Date Payable Wednesday, 03
XYZ Limited $2.00 Nov 20YY Friday, 05 Dec Dec 20YY Monday, 22 Dec
TTT Limited $3.00 20YY 20YY

Ex-div is two business days before record date and, to be entitled for dividends, you need to
purchase shares at least 1 business days prior to the ex-div date. You will only receive dividends
from the 200 XYZ shares you purchased on Monday Nov 10th. As such, your total
dividend income = $2.00*200 = $400.

Part 1.B

You were asked to prepare your company’s dividend payout plan over the next four years,
based on Residual Dividend Payout policy. Each year’s capital investment needed is estimated to be
$50 million dollars, your company has a target Debt/Equity (D/E) ratio of 3/2, and the forecasted
annual net incomes (in $mil) are provided in the table below. Calculate and briefly explain
each year’s dividend payment and, based on your calculations, complete this dividend
payout table.

Year 1 Year 2 Year 3 Year 4

Capital Investment Needed $50 $50 $50 $50

Net Income $20 $26 $18 $32

Equity Investment Needed

Equity Available

Annual Dividend Payment

Equity Needed = Capital Needed * Equity/(Debt+Equity) = $50 * 2/5 = $20 per year;
Equity Available = Net Income;
Dividend = Equity Available – Equity Needed. When the difference is negative, no dividend will be
paid out.

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Question #2
Part 2.A
In June 2015, when the exchange rate was $1.40/Euro, Canada Moose Limited (CML) ordered
parts for next year’s production from a German company. They agreed to a price of 500,000
Euros, to be paid when the parts were delivered in a year’s time. If the firm (CML Limited) does not
hedge at all, its cost for Euros is simply the spot exchange rate in June 2016. Answer the
following questions.
(a) What happens to CML’s sales if the Canadian dollar strengthens during the
year? What if the dollar weakens?
(b) The one-year forward exchange rate is $1.55/Euro. Discuss how the company
can hedge its exchange rate risk using a forward contract with a forward rate. What are the
pros and cons of using such a hedging strategy?
CML is to pay in Euro. Without hedging, the company has to pay more when Euro strengthens against
dollar, and pay less when Euro weakens against dollar.
If CML uses a forward contract, its cost is “locked in” at 500,000*1.55 = $775,000.
The benefit of using forward contract is to remove uncertainty, while the “cost” is that the
company will have to pay relatively more if Canadian dollars strengthens in a year’s time.
Part 2.B
Canadian Equipment Limited (CEL) has an investment opportunity in Japan. This project costs 1,000
million Japanese Yen now and is expected to produce cash flows of 200 million Yen in year one, 260
million Yen in year two, and 350 Yen million in year three. In addition, this subsidiary in Japan can be
sold at the end of three years for an estimated amount of 800 million Yen. The current spot exchange
rate is C$0.0100/Yen. The current risk-free rate in Canada is 1.0%, compared to that in Japan of
5.0%. The appropriate discount rate for the project is estimated to be 10%, the Canadian cost of
capital for the company. Using home currency approach, calculate the net present value (NPV)
of CEL’s investment project.
Step 1: Canadian dollar will strengthen against Japanese Yen. Using the approximation
UIP formula to estimate future FX rates:
E(St) = S0 * [1+ (Rfc – Rcad)]  E(S1) = (1/0.01)*[1+(0.050-0.010)] = $0.0096/Yen; E(S2)
= $0.0092/Yen; E(S3) = $0.0089/Yen.
Step 2: Calculate C$-denominated future cash flows:
CF0 = -$10.000; CF1 = $1.923; CF2 = $2.404; CF3 = $10.223.
Step 3: Use $ cash flows and $ discount rate to compute NPV:
NPV = -10.000 + 1.748 + 1.987 + 7.681 = $1.416 million.
Part 2.C
The exchange rate for Australian dollar is currently A$1.02/C$, and is expected to become A$1.10/C$
by the end of next year. Answer and briefly explain the following:
a) What do you think about the relative inflation rates in Canada and Australia – which one is higher?
b)What do you think about the relative real interest rates in Canada and Australia – which one is higher?
If the “high five” equations hold true, inflation rate should be higher in Australia (RPPP) while
real rates should be the same in the two countries (GFE).

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Question #3
Part 3.A
Suppose Company A can borrow at a floating rate equal to LIBOR plus 1.2% or at a fixed rate of
6.25%. Company B can borrow at a floating rae of LIBOR plus 2.0% or at a fixed rate of 5.75%.
Company A currently uses floating-rate loan but desires a fixed-rate loan, whereas Company B
desires a floating-rate loan but it currently pays fixed. Both companies contacted you, a swap
dealer, for a deal. Among the three possible fixed-for-floating interest rate swap deals offered
below, choose the one deal that suits both Companies and, based on this chosen deal, draw an
illustration graph of how this swap deal works and also calculate your (i.e. swap dealer’s)
profit (in % terms).
a) 5.85% - for – (LIBOR plus 1.65%) interest rate swap;
b) 6.30% - for – (LIBOR plus 1.15%) interest rate swap;
c) 5.60% - for – (LIBOR plus 2.20%) interest rate swap.

In order for a deal to be suitable for both Companies, the fixed rate must be lower than 6.25% (for
Company A) and the floating rate must be lower than LIBOR plus 2.0% (for Company B). Therefore,
the only deal that suits both companies is swap (a). Company A prefers fixed-rate loan and it can
borrow at a lower rate of 5.85% than borrowing on its own. Company B prefers variable-rate loan and
it can borrow at a lower rate of 1.65%.

On the fixed-rate loan side, Company A pays you 5.85% and you pay B 5.75%  profit of 0.10%. On the
variable-rate end, B pays you (LIBOR+1.65%) and you pay A (LIBOR+1.2%)  0.45%. Your total
profit is therefore 0.55%, or 55 basis points.
Graph should look similar to the one in Figure 24.7 in the textbook.

Part 3.B
Sarah grows and exports cocoa, and she wants to hedge against adverse price movement using a 3-
month European-style cocoa option contracts. European option contracts can only be exercised when
the contracts mature in 3 months’ time.

Each option contract is for 10 metric tons, and Sarah expects that her produce will be around 20 tons.
The option’s pre-specified strike price (exercise price) is $1440 per ton. Should Sarah use call option or
put option contracts? Calculate and compare Sarah’s cocoa sales payoff in 3 months’ time, with
vs. without using the option contracts, for cocoa prices of $1380, $1420, $1480, and $1550.

Sarah should use PUT option contracts, given that she wants to sell cocoa. The option contracts will
allow her to sell her produce at a minimum price of $1440 per ton. She can exercise her PUT
contract whenever the market price of cocoa is below the strike price.

Without Option Total Payoff With Option Total Payoff Benefit

1380 1380 27600 1440 28800 1200
1420 1420 28400 1440 28800 400
1480 1480 29600 1480 29600 0
1550 1550 31000 1550 31000 0

4. The maximum growth rate for a firm which maintains a constant debt-equity ratio and which
avoids additional external equity financing is called:
C. The sustainable growth rate

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Personally Selected Quiz Questions

1. Pickup Industries has a profit margin of 15% and a dividend payout of 40%. Last year’s sales were
$600 million and total assets were $400 million. None of the liabilities vary directly with sales, but
assets and costs do. If the sales growth rate for Pickup Industries is 20%, how much external
financing is needed?
C) $15.2 million
Sales = $720 Assets = $480 NI = $108 R.E. = $64.80 Assets required = $480
Assets in place = $400 + $64.80

2. Suppose a firm has net income of $100 million and a profit margin equal to 14%. If the firm is
working at 2/3 capacity, then its full capacity sales are:
E) $1,071 million
NI = $100 NI/Sales = 14%Sales = $714.29
Sales @ full capacity = Sales / (2/3)Sales @ full capacity = $1,071.43

3. Moore Money Inc. has a profit margin of 11% and a retention ratio of 70%. Last year the firm had sales
of $500,000 and total assets of $1 million. What is the firm’s internal growth rate?
D) 4.0%
ROA = NI/Assets = (NI/Sales) * (Sales/Assets) = 11%*(500/1,000) g = ROA*R / (1-ROA*R)
= 5.5% ROA*R = 5.5% * 0.70 = 3.85% ROA = 5.5% R = 70%
Internal growth rate = 4%

4. One year ago, Tina purchased 200 shares of Addado Companies at a cost of $38.90 a share.
The stock pays quarterly dividends of $0.65 per share. Today, Tina sold her shares for
$41.20 per share. How much dividend income did Tina receive as a result of her
ownership of these shares?
D) $520
Annual dividend income = $0.65 per quarter * 4 quarters * 200 shares
= $2.60*200 = $520
5. What is the expected portfolio return given the following information:
Asset Portfolio Weight Return
A 0.25 15%
B 0.25 20%
C 0.30 10%
D 0.20 35%
C. 18.75%
Portfolio Return = 0.25*15% + 0.25*20% + 0.30*10% + 0.20*35% = 18.75%
6. You own two risky assets, both of which plot on the security market line. Asset A has an
expected return of 12% and a beta of 0.8. Asset B has an expected return of 18% and a
beta of 1.4. If your portfolio beta is the same as the market portfolio, what proportion
of your funds are invested in asset A?
C) 67%
Portfolio beta = 1.0 = x*0.8 + (1-x)*1.41.0 = 1.4 – 0.6xx = 0.4/0.6 = 67%
7. Berkley's has expected earnings before interest and taxes of $3,800. Its unlevered cost of
capital is 14.5% and its tax rate is 35%. Berkley's has debt valued at $2,200. This debt has
a 7.5% discount rate and pays interest annually. What is the firm's cost of equity?
E) 15.14%

VU = [$3,800*(1-0 .35)]/0.145 = $17,034.48

VL = $17,034.48 + (0.35* $2,200) = $17,804.48
E = VL - D = $17,804.48 - $2,200 = $15,604.48
RE =0 .145 + (0.145 - 0.075)* ($2,200/$15,604.48)*(1-0 .35) =0 .1514148 = 15.14%
WACC = [($15,604.48/$17,804.48)*0.1514148] + [($2,200/$17,804.48)*0.075*(1-0 .35)] = 13.87%
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8. TOYSrYOU needs to raise $5 million in a rights offering. If the subscription price is $10/share, the stock
price is $12.50/share; there are 4 million shares outstanding, how many rights are required to
purchase one of the new shares? What is the value of a right?
C) 8.0 Rights required: (10/share * 4 million shares / $5 million = 8)
Value of a right: $0.28

9. A Canadian firm is considering purchasing a subsidiary in Great Britain. The subsidiary costs £16 mil
now to establish and will generate cash inflows of £7.6 mil per year at the end of each of the next three
years. After that, for valuation, the company will be considered to be worthless. The current exchange
rate is £0.83 per CAD$1. The Canadian annual inflation rate is expected to be 4% over this period. The
current risk-free rates (Rf) of interest in Canada is 5% per annum and 8% in Great Britain.
If uncovered interest parity holds, what is the expected spot rate two years from now?
D) 0.881
St = S0 * [1 + (Rforeign - Rcad)]t
= 0.83 * [1 + (8% - 5%)]2 = 0.881

10. Berkley's has expected earnings before interest and taxes (EBIT) of $3,800. Its unlevered cost of capital
is 14.5% and its tax rate is 35%. Berkley's has debt valued at $2,200. This debt has a 7.5% discount rate
and pays interest annually. What is the firm's cost of equity?
Step 1: Value of the
C) 13.87%
firm, unlevered
#1. Vu = ( EBIT - I ) * (1 -Tc) = $3,800 * 0.65 = $17,804 Step 2: Value of firm,
Ru 14.5% levered
#2. VL = VL + D * Tc = $17,034 + $2,200 * 0.35 = $17,804 Step 3: Value of
equity, levered
#3. VL = D + E => E = VL - D = $17,804 - $2,200 = $15,604
Step 4: Cost of equity,
#4. Re = Ru + (Ru - Rd) * (D/E) * (1 - Tc) levered
= 14.5% + (14.5% - 7.5%) x (2,200/15,604) * 0.65 = 15.14% Step 5: WACC, levered

11. The slope of the security market line is the _____.

E) market risk premium

12. Which one of the following categories has the lowest positive, NON-ZERO, risk premium?
B) Long-term bonds

13. Which one is an example of diversifiable risk? A new government regulation on aircraft engines.

Both forward and futures contracts lock in a

Forward and Futures Contracts
price today for the purchase/sale of an underlying asset
at a future point in time.
Forward contracts are usually negotiated between
individual parties.
Futures contracts are standardized, traded on formal
exchanges, and follow a daily settlement process.
LONG position: agrees today to buy the underlying
asset, in the future, and to pay the pre-specified price;
SHORT position: agrees today to sell the underlying
asset, in the future, and to receive the pre-specified price.
* No money changes hands at the initial time when the
contracts are made, between the long and short parties.
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FORMULAS CFA Ethics

Just pick the ethical
Internal Growth Rate choices + ask the
g = (p*S*R) / (A - p*S*R) supervisor.
g = ROA*R / (1 - ROA*R)

Sustainable Growth Rate

sgr = g = ROE*R / (1- ROE*R)

Total Risk
systematic risk + unsystematic risk

Capital Asset Pricing Model (CAPM)

E(Ra) = Rf + βa [E(Rm) - Rf]
Case 2
Ri = Rf + βi x ( Rm - Rf )
VL = VU + Tc x D
* this translates risk into return
Reward-To-Risk Ratio
VL = maximum firm value slope = ( E(Ra) - Rf )
Cost of Capital
VU = value of firm without debt Ba - 0
WACC = Rd x (1 - Tc) x wd + Rp x wp +Re x we
D = total debt
Rd = before-tax cost of new debt
market risk premium

= relative to total market capitalization

Rd (1 - Tc) = after-tax cost of new debt Fantastic Five Formulas
Net Debt = ST debt + LT debt - Cash

Tc = marginal corporate tax rate RPPP

Rp = cost of preferred shares E(S1) = S0 * [1 + (hfc - hcad)]
Total Debt = ST debt + LT debt

Re = cost of common equity

= ( Rm - Rf )

w = proportion of debt (D/V) IRP

= relative to OCF

= equity (E/V) F1 = S0 * [1+ (Rfc - Rcad)]

= preferred stock (P/V)
= "leverage ratio"

UFR
Goodwill F1 = E(S1)
* difference between purchase price and estimated
fair market value of the purchased net assets Uncovered Interest Parity (UIP) *
* must be depreciated/amortized going forward E(S1) = S0 [1 + (Rfc - Rcad)] — for 1 period
E (St) = S0 [1 + (Rfc - Rcad)] — for t periods
Cost of Acquisition
VAB = VA + (VB + ΔV) Generalized/Intl. Fisher Effect (GFE) *
GFE = Rcad - hcad
VB* or (VB + ΔV) = represents the value of the target = Rfc - hfc
firm B to the acquiring firm A
Cost of Preferred Stocks
NPV of Acquisition Rp = Divp Rp = return for preferred
NPV = VB* – cost of acquisition Pp Pp = preferred stock
Cash acquisition: NPV = VB* – cash cost D1 = next year div
Dividend Growth Model g = growth rate
Project Discount Rate (Project A) P0 = D1 Re = total return measure
x

DRa =Rf + βa x ( Rm - Rf ) Re - g

Discount Rates > IRR NPV < 0 (neg) g = retention ratio x ROE
= IRR NPV = 0 (equal)
< IRR NPV > 0 (pos) WACC = cost of debt x (1 - corp. tax rate) x Wd
+ Rp + Wp
+ Re + We
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100% = Wd + Wp + We
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SWAP DEALER EXAMPLE

Future discounted Cash Flows from assets (CF)
CF = EBIT * (1 - Tc) + Depr. - Add_NWC - Cap. Spending

Profit Margin = Net Income

Sales
Sales = Net Income RE = NI x (1 - Div %)
Profit Margin

Full Capacity = Current Sales

Capacity

External Financing Needed

EFN = $assets required - $assets available

Risk Premium = expected return - expected risk-free rate

CAPM = Rf + β ( E(Rm) - Rf )
Rf = Risk free rate (min. we should expect)
β = systematic risk
Rm - Ef = market risk premium

Expected Return of a Portfolio ->

Volatility of a Portfolio
Step 1: Portfolio Return
Step 2: Expected portfolio return (as indiv. asset)
Step 3: Portfolio variance & Std. Dev

σ^2p = (x^2a*σ^2a) + (x^2b*σ^2b) + 2xa*xb*CORRa,b*σa*σb

Both firms are 100% equity-financed. Firm A can acquire firm B for $82,500 in the form of either cash or
stock. The synergy value of the deal is $12,500.
Answer 1-3 using this information.

1. What is the price per share of the post-merger firm following a cash acquisition? (Chapter 23)
B) $25.50

2. What is the merger premium over firm B's stock price?

C) 10.00%

3. What is the NPV of the acquisition if cash is used?

B) $5,000

4. Suppose the employees of Air Canada borrowed heavily to buy all of the firm's stock and take the
company private. This would be an example of a(n) _______________.
E) leveraged buyout

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14. Company A can borrow at either an 8.50% fixed rate or a floating rate of prime + 1.75%. Company B can
borrow at either a floating rate of prime + 1.25% or a fixed rate of 8.65%. Company A prefers a floating rate but
currently borrows at fixed, whereas Company B prefers a fixed rate but currently borrows at floating. Which
one of the following terms would be acceptable to both Company A and B (& allowing the dealer to
make a profit) if they opted to enter an interest rate swap?
C) 8.60% fixed for prime + 1.30% floating
The floating rate is a variable rate (prime + rate). Each company has its preferred method, but would
need to check what interest charge is later. Consider whether Company A and B would save more
money by going through a swap dealer or by going through their bank.

15. You buy 15 wheat futures contracts when the futures price is $2.61 per bushel (each contract is for 5,000
bushels). The actual wheat price on the maturity date is $2.21. What is your payoff?
A) -$30,000
(15*5000)*2.61 = $195,750 (15*5000)*2.21 = $165,750
195,750 – 165,750 = 30,000 You paid 30,000 more than what its worth on maturity.

16. The Tinslow Co. has 125,000 shares of stock outstanding at a market price of $93 a share. The company has
just announced a 7-for-3 stock split. What will the market price per share be after the split?
B) $39.86
(3/7) * $93 = $39.857

17. The board of directors of DDT Inc. declared a dividend of $0.75 per share payable on Monday, January 28 to
shareholders of record as of Monday, January 14. You owned 500 shares of DDT on Wednesday, January 9 when
the price was $7.50 per share. Under TSX rules and assuming no taxes and perfect markets, if you sell your 500
shares of DDT on Friday, January 11, what price will you receive, all else the same?
B) $3,375
$0.75*500 = 375 $7.50*500 = $3,750
$3,750 – $375 = $3,375

18. Treasury bills currently have a return of 3.5% and the market risk premium is 8%. If a firm has a beta of
1.6, what is its cost of equity?
D) 16.3%
Cost of Equity = Rf + βi x ( Rm - Rf)
= 3.5% + 1.6(8%)

19. All else equal, an increase in a firm's dividend payout ratio will decrease its sustainable growth rate
(because the retention rate goes down => growth rate goes down)

20. The higher the standard deviation of a risky asset, the greater the probability of losing more than 50% of
your investment in any one year. Higher standard deviation means less certainty.
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