FIN 540 MIDTERM/FIN 540 MIDTERM

Question 1
Which of the following statements about valuing a firm using the APV approach is most CORRECT?
Answer
The horizon value is calculated by discounting the free cash flows beyond the horizon date and any tax savings at the levered cost of equity.
The horizon value is calculated by discounting the free cash flows beyond the horizon date and any tax savings at the cost of debt.
The horizon value is calculated by discounting the expected earnings at the WACC.
The horizon value is calculated by discounting the free cash flows beyond the horizon date and any tax savings at the WACC.
The horizon value must always be more than 20 years in the future.
8 points
Question 2
Operating leases often have terms that include
Answer
maintenance of the equipment by the lessor.
full amortization over the life of the lease.
very high penalties if the lease is cancelled.
restrictions on how much the leased property can be used.
much longer lease periods than for most financial leases.
8 points
Question 3
From the lessee viewpoint the riskiness of the cash flows with the possible exception of the residual value is about the same as the riskiness of the lessee’s
Answer
equity cash flows.
capital budgeting project cash flows.
debt cash flows.
pension fund cash flows.
sales.
8 points
Question 4
Which of the following is generally NOT true and an advantage of going public?
Answer
Facilitates stockholder diversification.
Increases the liquidity of the firm’s stock.
Makes it easier to obtain new equity capital.
Establishes a market value for the firm.
Makes it easier for owner-managers to engage in profitable self-dealings.
8 points
Question 5
Which of the following statements is NOT
CORRECT?
Answer
When a corporations shares are owned by a few individuals who own most of the stock or are part of the firms management we say that the firm is closely or privately held.
Going public establishes a firms true intrinsic value and ensures that a liquid market will always exist for the firms shares.
Publicly owned companies have sold shares to investors who are not associated with management and they must register with and report to a regulatory agency such as the SEC.
When stock in a closely held corporation is offered to the public for the first time the transaction is called going public and the market for such stock is called the new issue market.
It is possible for a firm to go public and yet not raise any additional new capital.
8 points
Question 6
Which of the following statements is most CORRECT?
Answer
Tax considerations often play a part in mergers. If one firm has excess cash purchasing another firm exposes the purchasing firm to additional taxes. Thus firms with excess cash rarely undertake mergers.
The smaller the synergistic benefits of a particular merger the greater the scope for striking a bargain in negotiations and the higher the probability that the merger will be completed.
Since mergers are frequently financed by debt rather than equity a lower cost of debt or a greater debt capacity are rarely relevant considerations when considering a merger.
Managers who purchase other firms often assert that the new combined firm will enjoy benefits from diversification including more stable earnings. However since shareholders are free to diversify their own holdings and at whats probably a lower cost diversification benefits is generally not a valid motive for a publicly held firm.
Operating economies are never a motive for mergers.
8 points
Question 7
Which of the following statements is most CORRECT?
Answer
A conglomerate merger is one where a firm combines with another firm in the same industry.
Regulations in the United States prohibit acquiring firms from using common stock to purchase another firm.
Defensive mergers are designed to make a company less vulnerable to a takeover.
Hostle mergers always create value for the acquiring firm.
In a tender offer the target firms management always remain after the merger is completed.
8 points
Question 8
Which of the following statements is most CORRECT?
Answer
If new debt is used to refund old debt the correct discount rate to use in the refunding analysis is the before-tax cost of new debt.
The key benefits associated with refunding debt are the reduction in the firm’s debt ratio and the creation of more reserve borrowing capacity.
The mechanics of finding the NPV of a refunding decision are fairly straightforward. However the decision of when to refund is not always clear because it requires a forecast of future interest rates.
If a firm with a positive NPV refunding project delays refunding and interest rates rise the firm can still obtain the entire NPV by locking in a low coupon rate when the rates are low even though it actually refunds the debt after rates have risen.
Suppose a firm is considering refunding and interest rates rise during time when the analysis is being done. The rise in rates would tend to lower the expected price of the new bonds which would make them cheaper to the firm and thus increase the expected interest savings.
8 points
Question 9
Which of the following statements is most CORRECT?
Answer
In a private placement securities are sold to private (individual) investors rather than to institutions.
Private placements occur most frequently with stocks but bonds can also be sold in a private placement.
Private placements are convenient for issuers but the convenience is offset by higher flotation costs.
The SEC requires that all private placements be handled by a registered investment banker.
Private placements can generally bring in funds faster than is the case with public offerings.
8 points
Question 10
Chapter 7 of the Bankruptcy Act is designed to do which of the following?
Answer
Protect shareholders against creditors.
Establish the rules of reorganization for firms with projected cash flows that eventually will be sufficient to meet debt payments.
Ensure that the firm is viable after emerging from bankruptcy.
Allow the firm to negotiate with each creditor individually.
Provide safeguards against the withdrawal of assets by the owners of the bankrupt firm and allow insolvent debtors to discharge all of their obligations and to start over unhampered by a burden of prior debt.
8 points
Question 11
Which of the following statements is most CORRECT?
Answer
Leveraged buyouts (LBOs) occur when a firm issues equity and uses the proceeds to take a firm public.
In a typical LBO bondholders do well but shareholders see their value decline.
Firms are forbidden by law to sell any assets during the first five years following a leverage buyout.
LBOs are never backed by private equity firms.
LBOs typically use a lot of debt.
8 points
Question 12
Financial Accounting Standards Board (FASB) Statement #13 requires that for an unqualified audit report financial (or capital) leases must be included in the balance sheet by reporting the
Answer
residual value as a fixed asset.
residual value as a liability.
present value of future lease payments as an asset and also showing this same amount as an offsetting liability.
undiscounted sum of future lease payments as an asset and as an offsetting liability.
undiscounted sum of future lease payments less the residual value as an asset and as an offsetting liability.
8 points
Question 13
Which of the following statements concerning warrants is correct?
Answer
Bonds with warrants and convertible bonds both have option features that their holders can exercise if the underlying stocks price increases. However if the option is exercised the issuing companys debt declines if warrants were used but remains the same if it used convertibles.
Warrants are long-term put options that have value because holders can sell the firms common stock at the exercise price regardless of how low the market price drops.
Warrants are long-term call options that have value because holders can buy the firms common stock at the exercise price regardless of how high the stocks price has risen.
A firms investors would generally prefer to see it issue bonds with warrants than straight bonds because the warrants dilute the value of new shareholders and that value is transferred to existing shareholders.
A drawback to using warrants is that if the firm is very successful investors will be less likely to exercise the warrants and this will deprive the firm of receiving any new capital.
8 points
Question 14
Which of the following statements is most CORRECT?
Answer
Preferred stock generally has a higher component cost of capital to the firm than does common stock.
By law in most states all preferred stock must be cumulative meaning that the compounded total of all unpaid preferred dividends must be paid before any dividends can be paid on the firms common stock.
From the issuers point of view preferred stock is less risky than bonds.
Whereas common stock has an indefinite life preferred stocks always have a specific maturity date generally 25 years or less.
Unlike bonds preferred stock cannot have a convertible feature.
8 points
Question 15
Firms use defensive tactics to fight off undesired mergers. These tactics do not include
Answer
raising antitrust issues.
getting a white squire to purchase stock in the firm.
getting white knights to bid for the firm.
repurchasing their own stock.
changing the bylaws to eliminate supermajority voting requirements.
8 points
Question 16
Which of the following statements is most CORRECT?
Answer
The acquiring firms required rate of return in most horizontal
mergers will not be affected because the 2 firms will have similar betas.
Financial theory says that the choice of how to pay for a merger is really irrelevant because although it may affect the firm’s capital structure it will not affect its overall required rate of return.
The basic rationale for any financial merger is synergy and thus the estimation of proforma cash flows is the single most important part of the analysis.
In most mergers the benefits of synergy and the premium the acquirer pays over the market price are summed and then divided equally between the shareholders of the acquiring and target firms.
The primary rationale for most operating mergers is synergy.
8 points
Question 17
In the lease versus buy decision leasing is often preferable
Answer
because generally no down payment is required and there are no indirect interest costs.
because lease obligations do not affect the firms risk as seen by investors.
because the lessee owns the property at the end of the least term.
because the lessee may have greater flexibility in abandoning the project in which the leased property is used than if the lessee bought and owned the asset.
8 points
Question 18
Which of the following statements concerning common stock and the investment banking process is NOT CORRECT?
Answer
The preemptive right gives each existing common stockholder the right to purchase his or her proportionate share of a new stock issue.
If a firm sells 1000000 new shares of Class B stock the transaction occurs in the primary market.
Listing a large firm’s stock is often considered to be beneficial to stockholders because the increases in liquidity and reputation probably outweigh the additional costs to the firm.
Stockholders have the right to elect the firm’s directors who in turn select the officers who manage the business. If stockholders are dissatisfied with management’s performance an outside group may ask the stockholders to vote for it in an effort to take control of the business. This action is called a tender offer.
The announcement of a large issue of new stock could cause the stock price to fall. This loss is called market pressure and it is treated as a flotation cost because it is a cost to stockholders that is associated with the new issue.
8 points
Question 19
New York Waste (NYW) is considering refunding a $50000000 annual payment 14% coupon 30-year bond issue that was issued 5 years ago. It has been amortizing $3 million of flotation costs on these bonds over their 30-year life. The company could sell a new issue of 25-year bonds at an annual interest rate of 11.67% in today’s market. A call premium of 14% would be required to retire the old bonds and flotation costs on the new issue would amount to $3 million. NYW’s marginal tax rate is 40%. The new bonds would be issued when the old bonds are called.
What will the after-tax annual interest savings for NYW be if the refunding takes place?
Answer
$664050
$699000
$768900
$845790
$930369
8 points
Question 20
The City of Charleston issued $3000000 of 8% coupon 30-year semiannual payment tax-exempt muni bonds 10 years ago. The bonds had 10 years of call protection but now the bonds can be called if the city chooses to do so. The call premium would be 6% of the face amount. New 20-year 6% semiannual payment bonds can be sold at par but flotation costs on this issue would be 2% of the amount of bonds sold. What is the net present value of the refunding? Note that cities pay no income taxes hence taxes are not relevant.
Answer
$453443
$476115
$499921
$524917
$551163
8 points
Question 21
Warren Corporations stock sells for $42 per share. The company wants to sell some 20-year annual interest $1000 par value bonds. Each bond would have 75 warrants attached to it each exercisable into one share of stock at an exercise price of $47. The firms straight bonds yield 10%. Each warrant is expected to have a market value of $2.00 given that the stock sells for $42. What coupon interest rate must the company set on the bonds in order to sell the bonds-with-warrants at par?
Answer
7.83%
8.24%
8.65%
9.08%
9.54%
8 points
Question 22
Upstate Water Company just sold a bond with 50 warrants attached. The bonds have a 20-year maturity and an annual coupon of 12% and they were issued at their $1000 par value. The current yield on similar straight bonds is 15%. What is the implied value of each warrant?
Answer
$3.76
$3.94
$4.14
$4.35
$4.56
8 points
Question 23
Chocolate Factory’s convertible debentures were issued at their $1000 par value in 2009. At any time prior to maturity on February 1 2029 a debenture holder can exchange a bond for 25 shares of common stock. What is the conversion price Pc?
Answer
$40.00
$42.00
$44.10
$46.31
$48.62
8 points
Question 24
A parent holding company sells shares in its subsidiary such that the parent now owns only 65% of the subsidiary and thus the tax returns of the parent and its subsidiary can’t be consolidated. The parent receives annual dividends from the subsidiary of $2500000. If the parent’s marginal tax rate is 34% and if the exclusion on intercompany dividends is 70% what is the effective tax rate on the intercompany dividends and how much net dividends are received?
Answer
10.2%; $2245000
10.2%; $2135000
23.8%; $1905000
10.2%; $1750000
34.0%; $1650000
8 points
Question 25
Kelly Tubes is considering a merger with Reilly Tires. Reillys market-determined beta is 0.9 and the firm currently is financed with 20% debt at an interest rate of 8% and its tax rate is 25%. If Kelly acquires Reilly it will increase the debt to 60% at an interest rate of 9% and the tax rate will increase to 35%. The risk-free rate is 6% and the market risk premium is 4%. What will Reillys required rate of return on equity be after it is acquired?
Answer
7.4%
8.9%
9.3%
9.6%
9.7%
8 points