- Information
- AI Chat
Final Exam sample questions
Corporate Finance (7211AFE)
Griffith University
Students also viewed
- Work Values Assessment-1-1
- Multiple intelligence
- Many individuals are drawn to teaching because of their passion for helping others learn and grow
- Trust and Accounting
- Sustainable Tourism - Lecture notes, lectures 1 - 12 - Complete notes from all course lectures
- Int. Food & Beverage Mgt. - Lecture notes, lectures 1 - 12 - Complete notes from all course lectures
Preview text
7211AFE Corporate Finance – Practice Questions for Final Exam
Question 1 The risk-free rate of return is 4% and the market risk premium is 8%. What is the expected rate of return on a stock with a beta of 1? Answer: 14% CAPM R = Rf + b(Rm-Rf) = 4% + 1*8% = 14%
Question 2 Assume that Diamond Ltd’s last dividend was $2 per share and the dividend is expected to grow at 7% indefinitely. The shares currently sell for $30. What is Diamond Ltd’s cost of equity capital? Answer: 14%
Question 3 Nuovo, Inc. stock has a beta of .86 and an expected return of 10 percent. The risk-free rate of return is 3 percent and the market rate of return is 11 percent. Is this stock underpriced or overpriced? Why? CAPM= 10,08, RRR=8,4% Answer: Nuovo stock is underpriced.
Question 4 EBIT for Sharks Ltd is $163 and the cost of capital (Ru) is 20%. Taxes are 39%. What is the value of the firm? Answer: $
Question 5 The expected return on HiLo stock is 13 % while the expected return on the market is 11%. The beta of HiLo is 1. What is the risk-free rate of return? Answer: 4%
Question 6 Priscilla owns 500 shares of Delta stock. The company recently issued a statement that it will pay a $1 per share dividend this year and a $.50 per share dividend next year. Priscilla does not want any dividend this year but does want as much dividend income as possible next year. Her required return on this stock is 12 percent. Ignoring taxes, what will Priscilla’s homemade dividend per share be next year? Answer: $1.
Question 7 Calculate the expected return from the following information:
Event Prob. Of event happening Return
A .25.
B .50.
C .20.
D .05 -.
Answer: 0.
Question 8 What is the market return if the expected return on asset A is 15% and the 10-year government bond rate is 6%. Beta for asset A is .9. Answer: 16%
Question 9 What is the portfolio variance if 30 percent is invested in stock S and 70 percent is invested in stock T?
State of Probability of Returns if State Occurs Economy State of Economy Stock S Stock T Boom 40% 12% 20% Normal 60% 6% 4% Answer: 0. We now have the payoffs in each state: Use equation (28) E(RP) = pr(boom) ×payoff(boom) + pr(normal) ×payoff(normal) = 0×0+0×0 = 0. Now use equation (29) Var(RP) = 0 × (0.176-0) 2 + 0 × (0.046-0) 2 = 0.
Question 10 Starfish limited has a WACC (unadjusted) of 12%. It can borrow at 8%. Assuming that the company has a target capital structure of 80% equity and 20% debt, what is its cost of equity? Answer: 13%
Question 11 Merlo, Inc. maintains a debt-equity ratio of .40 and follows a residual dividend policy. The company has after-tax earnings of $1,600 for the year and needs $1,400 for new investments. What is the total amount Merlo will pay out in dividends this year? Answer: $
Question 12 You recently purchased a stock that is expected to earn 12 % in a booming economy, 8 % in a normal economy and lose 5 % in a recessionary economy. There is a 15 % probability of a boom, a 75 % chance of a normal economy, and a 10 % chance of a recession. What is your expected rate of return on this stock? Answer: 7 %
Question 13 Shares are currently selling for $4. At the beginning of the year you bought them for $4 and during the year a dividend of 21 cents per share was paid. What is the return? Answer: 10%
Question 14 Which one of the following stocks is correctly priced if the risk-free rate of return is 2. percent and the market risk premium is 8 percent?
Question 20 You own 300 shares of Abco, Inc. stock. The company has stated that it plans on issuing a dividend of $.60 a share at the end of this year and then issuing a final liquidating dividend of $2 a share at the end of next year. Your required rate of return is 9 percent. Ignoring taxes, what is the value of one share of this stock today? Answer: $2.
Question 21 Astra limited company sells a slice of pizza for $1. The variable cost is 80 cents per slice and the marketing operation has fixed costs of $360 000 per year. Depreciation is $60 000 per year. What is the accounting break-even? Answer: 1 050 000 slices of pizza
Question 22 Rosie’s Grill has a beta of 1, a stock price of $26 and an expected annual dividend of $1. The dividend growth rate is 4 %. The market has a 10 % rate of return and a risk premium of 6 %. What is the average expected cost of equity for Rosie’s Grill? Answer: 10 %
Question 23 What are the arithmetic and geometric average returns for a stock with annual returns of 21 %, 8 %, -32 %, 41 %, and 5 %? Answer: AM 8 %; GM 5 %
Question 24 Sparkle Inc has a debt-equity ratio of 1. Its weighted average cost of capital is 11%, and its cost of debt is 9%. The corporate tax is 35%. a) What is Sparkle’s cost of equity capital? b) What is Sparkle’s unlevered cost of equity? c) Sparkle is increasing its debt proportion in the firm (at the same cost) so that the debt- equity ratio is 1? What is the cost of capital then? Answers: a) 16%; b) 13%; c) 10%
Question 25 The Lakeside Inn is considering expanding their operations. Fixed costs are estimated at $92,000 a year. The variable cost per unit is estimated at $22. The estimated sales price is $37 per unit. What is the cash break-even point of this project? (Round to whole units) Answer: 6,
Question 26 Tom’s Ventures has a zero coupon bond issue outstanding that matures in thirteen years. The bonds are selling at 48 % of par value. The company’s tax rate is 34 %. What is the company’s after-tax cost of debt? Answer: 3 %
Question 27
Suppose that your firm has a cost of equity of 18% and a cost of debt of 8%. If the target D/E is 0 and the tax rate is 35%, what is the firm’s WACC? Answer: 13%
Question 28 A stock had returns of 8 percent, -2 percent, 4 percent, and 16 percent over the past four years. What is the standard deviation of this stock for the past four years? Answer: 7%
Question 29 Your firm has earnings before interest and taxes of $160,000. Both the book and the market value of debt is $300,000. Your unlevered cost of equity is 12% while your cost of debt is 8%. The tax rate is 35%. What is your weighted average cost of capital? Answer: 10%
Question 30 A company has preferred stock outstanding which pays a dividend of $6 per share a year. The current stock price is $75 per share. What is the cost of preferred stock? Answer: 8%
Question 31 You are considering a new project. The project has depreciation of $720, fixed costs of $6,000, and selling price per unit of $9. The variable cost per unit is $4. What is the accounting break-even level of production? Answer: 1,200 units
Question 32 Douglass Enterprises has a capital structure which is based on 40 percent debt, 10 percent preferred stock, and 50 percent common stock. The after-tax cost of debt is 6 percent, the cost of preferred is 7 percent, and the cost of common stock is 9 percent. The company is considering a project that is equally as risky as the overall firm. This project has initial costs of $125,000 and cash inflows of $76,000 a year for two years. What is the projected net present value? Should this project be accepted or rejected? Answer: $11,275, yes
Question 33 Katie’s Boutique has zero-coupon bonds outstanding that mature in four years. The bonds have a face value of $1,000 and a current market price of $820. What is the company’s pre- tax cost of debt? Answer: 5 %
Question 34 Spartan Co. has earnings of 25 million per year every year. Currently the firm has no debt and the cost of capital is 13%. If tax is 35% what is the value of the firm? Answer: $125m Earnings are $25m/year; no debt WACC = 0, t=0. VU = EBIT(1-t) / RU = (25m) (1-0) / 0 = $125m
b) What will it sell in two days time after the ex dividend date? c) What are the accounts affected after the dividends are paid and what will be their new balance? Answers: a) $23; b) $23 c) Cash $22 200 and Equity $187 200
Question 40 Uptown Interiors has decided to consider an alternative to cash dividend. Instead of paying a dividend, the firm will repurchase $5 200 worth of stock. a) What effect will this transaction have on the equity of the firm? b) How many shares were repurchased? (round your answer) c) How many shares will be outstanding? d) What is the new equity value? e) What will the price per share be after the repurchase? Answer: a) reduce; b) 219; c) 7 781; d) $184 800; e) same $23. a) If you repurchase the stock, this is similar to a cash dividend; your cash account falls by $5200 and so does your equity account. b) Since the price is 23 then you retire 219 shares Shr repurchased =cash/P= $5200/23 = 219 c) The number of shares outstanding falls from 8000 to 7781 (=8000-219). d) New equity value, E’ = E – cash = 190,000 – 5200 = 184, e) Since stock repurchases do not impact the value of the firm, price/share remains unchanged at $23.
Question 41 Shirley’s and Son have a debt-equity ratio of .60 and a tax rate of 35 %. The firm does not issue preferred stock. The cost of equity is 10 % and the cost of debt is 8 %. What is Shirley’s weighted average cost of capital? Answer: 8 %
Question 42 You are an investor in BHP and own 100 shares. BHP shares sell for $41. The company is about to pay a $1 dividend but you prefer a $3 dividend. What will you do to receive the desired income of $300? Answer: sell 5 shares ex dividend
Question 43 Today, you sold 200 shares of SLG Inc. stock. Your total return on these shares is 12. percent. You purchased the shares one year ago at a price of $28 a share. You have received a total of $280 in dividends over the course of the year. What is your capital gains yield on this investment? Answer: 7 % -1 0 28 P0+1 DPS = Div/shares = 280/200 = 1. ret = (DPS+ch_P)/P_1 => 12% = (1 + P0-28)/28 => P0=30. ch_P/P_1 = (P0-P_1)/P_1 = (30.6-28)/28 = 7%
Question 44 Caterpillar Inc. has 8 million shares of common stock outstanding, and 1 million 8% percent semi-annual bonds outstanding, par value $100 each. The common stock currently sells for $25 per share, and has a beta of 1, and the bonds have 10 years to maturity and sell for
93% of par. Cost of debt is 9%. The market risk premium is 10%, the return on risk free rate is 4%, and tax rate is 30%. a) What is the firm’s market value of debt and equity? b) Caterpillar is evaluating a new investment project that has the same risk as the overall firm, what is the rate that the firm should use to discount the project’s cash flows? Answer: a) 139, 200m; b) 12% MV of equity = #shares × price = 8m × 25 = $200m MV of debt = 1 × $93 = $139. E(Rm)-Rf = 0; Rf= 0; Beta= 1. CAPM: E(R) = 0 + 1(0) = 0. Cost of debt = YTM = 9% WACC = (200/339)(0) + (139.5/339)(0)(1-0) = 0.
Question 45 The fixed costs of a project are $8,000. The depreciation expense is $3,500 and the operating cash flow is $20,000. What is the degree of operating leverage for this project? Answer: 1.
Question 46 Jack’s Construction Co. has 80,000 bonds outstanding that are selling at par value. Bonds with similar characteristics are yielding 8 %. Face value of a bond is $1000. The company also has 4 million shares of common stock outstanding. The stock has a beta of 1 and sells for $40 a share. The U. Treasury bill is yielding 4 % and the market risk premium is 8 %. Jack’s tax rate is 35 %. What is Jack’s weighted average cost of capital? Answer: 10 %
Question 47 Stark company has decided to restructure its capital. Currently, it uses no debt financing. Following the restructuring, debt will be $1 million. The interest rate on the debt will be 9%. The company currently has 200 000 shares outstanding and the price per share is $20. If the restructuring is expected to increase EPS, what is the minimum level of EBIT that the firm’s management must be expecting? Answer: $360 000
Question 48 Strip Tavern has the cost of equity at 14% and the cost of debt at 6%. Assuming that the target debt/equity ratio is 50% and the company tax rate is 34%, calculate the overall cost of capital. Answer: 10%
Question 48b The Can-Do Co. is analysing a proposed project. The company expects to sell 12,000 units, plus or minus 4 percent. 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 percent range. The depreciation expense is $30,000 per year, over the 5 year life of the project, using the straight line. The tax rate is 34 percent. The sale price is estimated at $14 a unit, plus or minus 5 percent. a) What is the earnings before interest and taxes under the base case scenario?
Investors prefer the portfolio with the highest expected return for a given variance, or, the lowest variance for a given expected return
Discuss the information effect or the signalling effect of dividends. Dividends and Signals Asymmetric information – managers have more info about the health of the company than investors Information Content Effect > Changes in dividends convey information > Cause market reaction
- Dividend increases: Management believes it can be sustained, Expectation of higher future dividends, increasing present value, Signal of a healthy, growing firm
- Dividend decreases: Management believes it can no longer sustain the current level of dividends, Expectation of lower dividends indefinitely; decreasing PV, Signal of a firm that is having financial difficulties
Explain and graphically show, together with the associated formulas, the M&M proposition I and II with taxes. Optimal capital structure is almost 100% debt, each additional dollar of debt increases the CFA of firm
What are some examples of direct bankruptcy costs? Administrative and legal costs
According to the CAPM, the expected return on a risky asset depends on three components. Describe each component, and explain its role in determining expected return.
- The risk-free rate, Rf
- The market risk premium, E(RM) Rf
- The systematic risk of the asset relative to average, which we called its beta coefficient,
Explain the concept of ‘homemade dividend policy’. Homemade Dividend Policy Investors will not pay higher prices for firms with higher dividend payouts. In other words, dividend policy will have no impact on the value of the firm because investors can create whatever income stream they prefer by using homemade dividends. Homemade Dividend Policy = Tailored dividend policy created by individual investors to undo corporate dividend policy
Discuss and graphically show with the associated formulas the Capital Structure Theory when the firm has debt but not taxes. There is no optimal capital structure in this case, as the capital structure has no influence on the firms value, without taxes, the total value is unaffected by its capital structure
What are some real-world factors that may cause one dividend policy to be preferable to another? Different Tax rates, flotation costs, dividend restrictions, desire for current income, uncertainty resolution
What is diversification? What is the variable that plays the most important role in reducing the portfolio risk?
The Principle of Diversification: states that spreading an investment across many assets will eliminate some but not all of the risk. Diversification can substantially reduce the variability of returns without an equivalent reduction in expected returns Size of risk reduction depends on covariances between assets in the portfolio there is a minimum level of risk that cannot be diversified away and that is the systematic portion Unsystematic risk is essentially eliminated by diversification, but systematic risk cannot be reduced by a portfolio
Define the three forms of market efficiency. What do we mean when we say the markets are efficient? Capital Market Efficiency Efficient Capital Markets: A market in which security prices reflect available information → based on available information, there is no reason to believe that the current price is too low or too high. efficient markets hypothesis (EMH): The hypothesis that actual capital markets, such as the NYSE, are efficient. It means that, on average, you will earn a return that is appropriate for the risk undertaken and there is not a bias in prices that can be exploited to earn excess returns 3 forms:
- weak form efficiency: - Prices reflect all past market information such as price and volume
- investors cannot earn abnormal returns by trading on market information
- Implies that technical analysis will not lead to abnormal returns
- Empirical evidence indicates that markets are generally wfe
- semistrong form efficiency: - Prices reflect all publicly available information including trading information, annual reports, press releases, etc.
- investors cannot earn abnormal returns by trading on public information → fundamental analysis will not lead to abnormal returns
- strong form efficiency: - Prices reflect all information, including public and private
- investors could not earn abnormal returns regardless of the information they possessed
- Empirical evidence indicates that markets are NOT strong form efficient and that insiders could earn abnormal returns
What are the lessons learned from capital market history? Lessons from Capital Market History
- Data reflects two features often observed in financial markets: - There is a reward for bearing risk.
- The larger the potential reward, the larger the risk.
- This is called the risk-return trade-off
- There is a positive relationship between risk and return
Explain the meaning of the dividend clientele effect and why it is important. Clientele Effect Some investors prefer low dividend payouts and will buy stock in those companies that offer low dividend payouts Some investors prefer high dividend payouts and will buy stock in those companies that offer high dividend payouts → If a firms changes the dividend policy from low to high or vice versa, it doesn’t matter, it just changes its structure of investors
What are the components of total risk? Give examples of each. Total risk = systematic risk + unsystematic risk The standard deviation of returns is a measure of total risk For well-diversified portfolios, unsystematic risk is very small → almost = to the systematic risk
Systematic or unsystematic Risk Systematic or Non-Diversifiable Risk, market risk: That portion of an asset’s risk attributed to the market factors that affect all firms and cannot be eliminated through the process of diversification. Unsystematic or Diversifiable Risk asset-specific risk: That portion of an asset’s risk which is firm specific and can be eliminated through the process of diversification
What is CAPM? In equilibrium, what does CAPM implies? Shows the relationship between systematic risk and expected return Positive slope The higher the risk, the higher the return According to the CAPM, all stocks must lie on the SML, otherwise they would be under or overpriced. In equilibrium, all assets and portfolios must have the same reward-to-risk ratio and they all must equal the reward-to risk ratio for the market, If not, assets are undervalued or overvalued
Final Exam sample questions
Course: Corporate Finance (7211AFE)
University: Griffith University
This is a preview
Access to all documents
Get Unlimited Downloads
Improve your grades
Why is this page out of focus?
Why is this page out of focus?
Why is this page out of focus?
Why is this page out of focus?
Students also viewed
- Work Values Assessment-1-1
- Multiple intelligence
- Many individuals are drawn to teaching because of their passion for helping others learn and grow
- Trust and Accounting
- Sustainable Tourism - Lecture notes, lectures 1 - 12 - Complete notes from all course lectures
- Int. Food & Beverage Mgt. - Lecture notes, lectures 1 - 12 - Complete notes from all course lectures