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THE UNIVERSITY OF NEW SOUTH WALES FINS1613 BUSINESS FINANCE FINAL EXAM
OCTOBER / NOVEMBER 2009

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TIME ALLOWED - 2 HOURS TOTAL NUMBER OF QUESTIONS 50. ANSWER ALL QUESTIONS. ALL QUESTIONS ARE OF EQUAL VALUE. THERE IS NO NEGATIVE MARKING. THIS PAPER MUST NOT BE RETAINED BY THE CANDIDATE. CANDIDATES NEED TO BRING A PENCIL AND ERASER TO THE EXAMINATION. CANDIDATES NEED TO BRING A UNIVERSITY APPROVED CALCULATOR TO THE EXAM. MATHEMATICAL TABLES ARE PRINTED AT THE BACK OF THIS EXAM PAPER.

(5) (6)

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PRINT YOUR STUDENT NUMBER ON THE TOP RIGHT HAND CORNER OF THIS PAGE. ANSWER ALL QUESTIONS ON THE ANSWER SHEET PROVIDED. ALL ANSWERS MUST BE IN PENCIL.

FINS 1613 Final Exam

T2 2009

Multiple Choice - 50 Questions: 1 mark each. 1) If a firm follows a residual dividend policy, they will give precedence to: a) b) c) d) e) maintaining their desired debt-equity ratio over paying dividends paying a constant dividend over increasing retained earnings paying dividends over accepting positive investments maintaining a constant level of debt before paying dividends avoiding dividend cuts over changing the debt-equity ratio

2)

An investment project is most likely to be accepted by the payback period rule and not accepted by the NPV rule if the project has a) b) c) d) e) a large initial investment with moderate positive cash flows over a very long period of time. a very large negative cash flow at the termination of the project. most of the cash flows at the beginning of the project. all projects approved by the payback period rule will be accepted by the NPV rule. The payback period rule and the NPV rule cannot be used to evaluate the same type of projects.

3) Cross International is an all equity company. You are given the following information for Cross: EBIT = $880 000 forever Corporate tax rate = 25% Cost of equity = 12% The company is in the process of issuing $1 000 000 of bonds at par that carry a 11.50% annual coupon. What is the levered value of the firm? Assume M&M under the classical tax case. a) b) c) d) e) $9,800,000 $8,000,000 $5,750,000 $6,655,250 $5,528,750

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4)

The Global Advertising Company has a marginal tax rate of 40 percent. The company can raise debt at a 12 percent interest rate and the last dividend paid by Global was $0.90. Globals common stock is selling for $8.59 per share, and its expected growth rate in earnings and dividends is 5 percent. Global plans to finance all capital expenditures with 30 percent debt and 70 percent equity. If the firm has sufficient retained earnings to fund the equity portion of its capital budget, what is the firms weighted average cost of capital after corporate tax under a classical tax system? a) b) c) d) e) 11.95% 12.22% 12.88% 13.36% 14.21%

5)

The maximum firm value, according to the static theory of capital structure, occurs at a point where the: a) b) c) d) e) value of a levered firm initially begins to exceed that of an unlevered firm financial distress costs are equal to zero value of the firm is equal to the value defined by M&M Proposition I, with tax value of the firm, as defined by M&M Proposition I, with tax, is exactly equal to the value of the firm, as defined by M&M Proposition I, without tax value of the firm equalizes the costs of financial distress with the present value of the tax shield on debt

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6)

Express Shopping Centres Inc. is considering expanding into the vacant land next door. This would require an outlay of $7.38 million. It is forecast that the additional complex will generate earnings before tax of $960,000 next year and that these earnings would grow at a rate of 4% per annum into the foreseeable future. Express pays company tax at a rate of 30% and has a real cost of capital of 8.5%. The Reserve Bank of Australia has forecast inflation to be 2.5% over the foreseeable future. What is the NPV of the expansion project? a) b) c) d) e) $1,937,157.71 $2,220,000.00 $3,650,482.00 $5,930,225.30 $7,553,333.33

7)

Auto Parts Ltds last dividend, D0, was $0.50, and the company expects to experience no growth for the next 2 years. However, Auto Parts will grow at an annual rate of 5 percent in the third and fourth years, and, beginning with the fifth year, it should attain a 10 percent growth rate that it will sustain thereafter. Auto Parts has a required rate of return of 12 percent. What should be the price per share of Auto Parts stock at the end of the second year immediately after the second year dividend payment? a) b) c) d) e) $19.98 $25.08 $31.21 $19.48 $27.55

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8)

Given the following probability distribution, what are the expected return and the standard deviation of returns for Security J? State Probability 1 0.2 2 0.6 3 0.2 a) b) c) d) e) RJ 10% 15% 20%

15%; 6.50% 12%; 5.18% 15%; 3.16% 15%; 10.00% None of the above.

9)

Blue & Co. is an all-equity firm with a total market value of $230,000. The firm has 25,000 shares of stock outstanding. Management is considering issuing $100,000 of debt at an interest rate of 7 percent and using the proceeds to repurchase shares. Management estimates that the economy will be fairly normal and thus the firm's earnings before interest and taxes (EBIT) will be $60,000. Assume the share price remains constant and ignore taxes. What is the anticipated earnings per share (EPS) if the debt is issued? a) b) c) d) e) $3.20 $3.46 $3.54 $3.75 $3.82

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10)

A post-completion audit of investment projects is important because: a) b) c) d) e) wasted expenditure may be avoided if internal control systems are in place. approval of an investment proposal is required before expenditure can take place. accountants need to understand the capital expenditure process when auditing it. it provides valuable information for future decision making. finance managers cannot forecast a projects net cash flows until it is completed.

11)

Financial managers should strive to maximize the current value per share of the existing stock because: a) b) c) d) e) doing so guarantees the company will grow in size at the maximum possible rate. doing so increases the salaries of all the employees. current stockholders are the owners of the corporation. doing so means the firm is growing in size faster than its competitors. the managers often receive shares of stock as part of their compensation.

12)

Plantation Holdings is considering the following independent, average-risk investment projects: Project Project 1 Project 2 Project 3 Project 4 Project 5 Size of Project $1.4 million 1.1 million 1.2 million 1.3 million 1.1 million Project IRR 11.5% 11.0% 10.0% 9.0% 8.5%

The company has a target capital structure that consists of 50 percent debt and 50 percent equity. Its before-tax cost of debt is 9.5 percent, its cost of equity is estimated to be 15.2 percent, and its net income is $2.2 million. The company tax rate is 30%. If the company follows a residual dividend policy, what will be its payout ratio? a) b) c) d) e) 12% 32% 43% 60% 100%

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13)

A portfolio manager has a $10 million portfolio, which consists of $1 million invested in 10 separate stocks. The portfolio beta is 1.2. The risk-free rate is 5 percent and the market risk premium is 6 percent. The manager sells one of the stocks in her portfolio for $1 million. The stock she sold has a beta of 0.9. She takes the $1 million and uses the money to purchase a new stock that has a beta of 1.6. What is the required return of her portfolio after purchasing this new stock? a) b) c) d) e) 10.75% 12.35% 12.62% 13.35% 14.60%

14)

If a firm applies its overall cost of capital to all its proposed projects, then the divisions within the firm will tend to: a) b) c) d) e) receive more funding if they represent the riskiest operations of the firm. avoid risky projects so that they will receive more funding. become less risky over time based on the projects that are accepted. have equal probabilities of receiving funding for their projects. propose less risky projects than if separate discount rates were applied to each project.

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15)

The risk-free rate is 6 percent and the market risk premium is 5 percent. Assume that required returns are based on the CAPM. Your $1 million portfolio consists of $700,000 invested in a stock that has a beta of 1.2 and $300,000 invested in a stock that has a beta of 0.8. Which of the following statements is most correct? a) b) The portfolios required return is less than 11 percent. If the risk-free rate remains unchanged but the market risk premium increases by 2 percentage points, the required return on your portfolio will increase by more than 2 percentage points. If the market risk premium remains unchanged but expected inflation increases by 2 percentage points, the required return on your portfolio will increase by more than 2 percentage points. If the stock market is efficient, your portfolios expected return should equal the expected return on the market, which is 11 percent. None of the statements above is correct.

c)

d) e)

16)

Taylor Industries pays out 40 percent of their quarterly earnings as a dividend each quarter. This firm has a(n) _____ dividend policy. a) b) c) d) e) residual special cyclical stable extra

17)

The expected rate of return on the common stock of Candy Corporation is 14 percent. The stocks dividend is expected to grow at a constant rate of 8 percent a year. The stock currently sells for $50 a share. Which of the following statements is most correct? a) b) c) d) e) The stocks dividend yield is 8 percent. The stocks dividend yield is 7 percent. The current dividend per share is $4.00. The stock price is expected to be $54 a share in one year. The stock price is expected to be $57 a share in one year.

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18)

Which one of the following actions by a corporate financial manager creates an agency problem? a) b) c) d) e) increasing current costs in order to increase the market value of the shareholders equity refusing to borrow money when doing so will create losses for the firm refusing to lower selling prices if doing so will reduce the net profits agreeing to pay bonuses based on the market value of the firms shares agreeing to expand the company at the expense of shareholders value

19)

XYZ declared a dividend of $.80 a share. The ex-dividend date is tomorrow. All else constant, you would expect the opening price tomorrow morning to be: a) b) c) d) e) $.80 lower than today's closing price lower by an amount approximately equal to the after-tax value of the dividend the same as today's closing price since the dividend is expected $.80 higher than today's closing price higher by an amount approximately equal to the after-tax value of the dividend

20)

Your firm requires an average accounting return (AAR) of at least 15 percent on all fixed Asset purchases. Currently, you are considering some new equipment costing $96,000. This equipment will have a 3-year life over which time it will be depreciated on a straight line basis to a zero book value. The annual net income from this project is estimated at $5,500, $12,400, and $17,600 for the 3 years. Should you accept this project based on the accounting rate of return? Why or why not? a) b) c) d) e) yes; because the AAR is less than 15 percent yes; because the AAR is equal to 15 percent yes; because the AAR is greater than 15 percent no; because the AAR is less than 15 percent no; because the AAR is equal to 15 percent

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21) Which of the following forms of compensation is the most likely to align the interests of managers and shareholders? a) b) c) d) e) A fixed salary. A salary that is linked to the companys sales. A salary that is linked to company profits. A salary that is paid partly in the form of the company's shares. A salary that is linked to the company's total market value.

22)

If you know that your firm is facing relatively poor prospects but needs new capital, and you know that investors do not have this information, signaling theory would predict that you would a) b) c) d) e) Issue debt to maintain the returns of equity holders. Issue equity to share the burden of decreased equity returns between old and new shareholders. Be indifferent between issuing debt and equity. Postpone going into capital markets until your firms prospects improve. Convey your inside information to investors using the media to eliminate the information asymmetry.

You are given the following information about Power Juice Inc. Use this information for the next two questions, numbers 23 and 24. Power Juice Inc. manufactures and distributes mineral-boosted fruit juice products. Power Juice is considering the development of a new watermelon with apple juice product. Power Juices CFO has collected the following information regarding the proposed project: The project will require that the company spend $1 million today (t = 0) to purchase a new machine. For tax purposes, the equipment will be depreciated on a straight-line basis. The company plans to use the machine for all 3 years of the project. At t = 3, the equipment is expected to have no salvage value. The project will require a $200,000 increase in net operating working capital at t = 0. The cost of the net operating working capital will be fully recovered at t = 3. The project is expected to increase the companys sales $1 million a year for three years (t = 1, 2, and 3). The projects annual operating costs (excluding depreciation) are expected to be 60 percent of sales. The companys tax rate is 40 percent. The company is extremely profitable, so any losses incurred from the prune juice project can be used to partially offset taxes paid on the companys other projects. The project has a WACC equal to 10 percent.

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23)

Refer to Power Juice Inc. What is the projects net present value? a) b) c) d) e) -$162,621 -$159,464 -$142,035 -$135,201 -$121,313

24)

Refer to Power Juice Inc. There is a possibility that the company may be forced to end the project at the end of year 2. If forced to end the project, the company will have to sell its equipment. If it sells its equipment at the end of year 2, Power Juice expects to sell it for $400,000. What is the after-tax salvage value that would be incorporated into the projects cash flow analysis? a) b) c) d) e) $353,333.33 $362,444.50 $373,333.33 $383,333.33 $400,000.00

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25)

Calculate the covariance in monthly returns on XYZ and STQ using the following data: 2005 Jan Feb Mar a) b) c) d) e) XYZ 0.056 0.015 0.023 STQ 0.225 0.125 0.049

0.00155 0.03210 0.00275 0.00103 None of these answers

26)

Tents and More sells specialty tents for mountain climbers. Their sales for last year included $65,000 of tents and $118,000 of climbing gear. For next year, management has decided to sell specialty sleeping bags also. The sales projections for next year include $71,000 of tents, $131,000 of climbing gear, and $48,000 of the sleeping bags. How much of next year's sales are derived from the side effects of adding the new product to their sales offerings? a) b) c) d) e) $11,000 $19,000 $31,000 $48,000 $67,000

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27)

Which one of the following statements is related to capital budgeting? a) b) c) d) e) a firm should monitor the ratio of debt to equity financing which it uses a firm should monitor the amount of its current assets as compared to its current liabilities a firm should consider the size, risk, and timing of an asset's cash flows before deciding to purchase that asset a firm should consider various types of loans offered by various lenders before taking out a loan a firm should determine the ideal level of inventory that should be kept on hand

28)

Deltona, USA is a development company that currently is financed with 100 percent equity. There are 15,000 shares outstanding at a market price of $50 a share. Deltona has earnings before interest and taxes (EBIT) of $20,000. The firm has decided to issue $250,000 of debt at a rate of 8 percent and use the proceeds to repurchase shares. Theresa owns 500 shares of Deltona and wants to use homemade leverage to offset the leverage used by Deltona. Theresa should: a) b) c) d) e) buy an additional 150 shares buy an additional 167 shares sell 133 shares sell 167 shares sell 250 shares

29)

Which of the following statements is most correct? a) b) c) d) e) A two-stock portfolio will always have a lower standard deviation than a one-stock portfolio. A two-stock portfolio will always have a lower beta than a one-stock portfolio. If portfolios are formed by randomly selecting stocks, a 10-stock portfolio will always have a lower beta than a one-stock portfolio. All of the statements above are correct. None of the statements above is correct.

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30)

Harper Holdings is considering a new project with the following cash flows: Year 0 1 2 3 4 Project Cash Flow -$13,000 12,000 8,000 7,000 -1,500

The firms weighted average cost of capital is 11 percent. What is the projects modified internal rate of return (MIRR)? a) b) c) d) e) 16.82% 21.68% 23.78% 24.90% 25.93%

31)

Corporations, potentially, have infinite life because: a) b) c) d) e) of limited liability ownership is transferable of the separation of ownership and control equity is not limited to the combined personal wealth of its owners they have to pay taxes

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32)

Which of the following statements is most correct? a) b) c) d) e) The present value of an annuity due will exceed the present value of an ordinary annuity (assuming all else equal). The future value of an annuity due will exceed the future value of an ordinary annuity (assuming all else equal). The nominal interest rate will always be greater than or equal to the effective annual interest rate. Statements a and b are correct. All of the statements above are correct.

33)

An investor has $5,000 invested in a stock that has an estimated beta of 1.2, and another $15,000 invested in the stock of the company for which she works. The risk-free rate (R f ) is 6 percent and the market risk premium (R M R f ) is also 6 percent. The investor calculates that the required rate of return on her total ($20,000) portfolio is 15 percent. What is the beta of the company for which she works? a) b) c) d) e) 1.6 1.7 1.8 1.9 None of these answers

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34)

Stock A has a beta of 0.8, Stock B has a beta of 1.0, and Stock C has a beta of 1.2. Portfolio P has equal amounts invested in each of the three stocks. Each of the stocks has a standard deviation of 25 percent. The returns of the three stocks are independent of one another (i.e., the correlation coefficients all equal zero). Assume that there is an increase in the market risk premium (R M R f ), but that the risk-free rate (R f ) remains unchanged. Which of the following statements is most correct? a) b) The required return of all three stocks will increase by the amount of the increase in the market risk premium. The required return on Stock A will increase by less than the increase in the market risk premium, while the required return on Stock C will increase by more than the increase in the market risk premium. The required return of all stocks will remain unchanged since there was no change in their betas. The required return of the average stock will remain unchanged, but the returns of riskier stocks (such as Stock C) will decrease while the returns of safer stocks (such as Stock A) will increase. The required return of the average stock will remain unchanged, but the returns of riskier stocks (such as Stock C) will increase while the returns of safer stocks (such as Stock A) will decrease.

c) d)

e)

35)

Which of the following statements is most correct? a) When comparing two projects using sensitivity analysis, the one with the steeper lines would be considered less risky, because a small error in estimating a variable, such as unit sales, would produce only a small error in the projects NPV. The primary advantage of simulation analysis over scenario analysis is that scenario analysis requires a relatively powerful computer, coupled with an efficient financial planning software package, whereas simulation analysis can be done using a PC with a spreadsheet program or even a calculator. Sensitivity analysis is incomplete because it fails to consider the range of likely values of key variables as reflected in their probability distributions. Sensitivity analysis is a risk analysis technique that considers both the sensitivity of NPV to changes in key variables and the interaction between the key variables. Statements c and d are correct.

b)

c) d) e)

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36)

From the following information, calculate the expected return and standard deviation of a portfolio that consists of 60% of Security A (expected return of 0.10 and standard deviation of 0.03) and 40% of Security B (expected return of 0.20 and standard deviation of 0.05), assuming the covariance between A and B is -0.0012. a) b) c) d) e) E(R) = 0.152, = 0.161 E(R) = 0.138, = 0.012 E(R) = 0.140, = 0.085 E(R) = 0.140, = 0.012 None of these answers.

37)

The Pegasus Company is considering a share issue to finance a new production facility. A pre-feasibility study shows that a total of 25 million dollars in new equity is needed to acquire new equipment. The direct costs of issue are estimated at 5% of the amount raised. How large does the issue need to be? a) b) c) d) e) $25,000,000 $26,250,000 $26,041,667 $25,853,429 $26,315,789

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You are given the following information about Biotronics Inc. Use this information for the next two questions, numbers 38 and 39. Biotronics Inc. is considering a project that has an up-front cost of $3 million and produces an expected cash flow of $500,000 at the end of each of the next five years. The projects cost of capital is 10 percent. 38) Refer to Biotronics Inc. On the basis of this information what is the projects net present value? a) b) c) d) e) -$1,104,607 -$ 875,203 -$ 506,498 $ 54,307 $ 105,999

39)

Refer to Biotronics Inc. If Biotronics goes ahead with this project today, the project will create additional opportunities five years from now (t = 5). Based on the best information that is available today, the company estimates that there is a 35 percent chance that its technology will be successful, in which case the future investment opportunities will have a net present value of $6 million at t = 5. There is a 65 percent chance that its technology will not succeed, in which case the future investment opportunities will have a net present value of -$6 million at t = 5. Biotronics does not have to decide today whether it wants to pursue these additional opportunities. Instead, it can wait until after it finds out if its technology is successful (t = 5) and then decide whether or not it wants to pursue these additional opportunities. However, Biotronics cannot pursue these additional opportunities in the future unless it makes the initial investment today. Given this, what is the estimated net present value of the project, after taking into account the future opportunities? a) b) c) d) e) -$2,222,265 -$1,104,607 $ 199,328 $61,947 $ 898,205

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40)

Stock A has a beta of 1.1, while Stock B has a beta of 0.9. The market risk premium, is 6 percent. The risk-free rate is 6.3 percent. Both stocks have a dividend, which is expected to grow at a constant rate of 7 percent a year. Assume that the market is in equilibrium and expected returns equal required returns. Which of the following statements is most correct? DIVi (Note: Dividend yield here is calculated as ) P0 a) b) c) d) e) Stock A must have a higher dividend yield than Stock B. Stock A must have a higher stock price than Stock B. Stock Bs dividend yield equals its expected dividend growth rate. Statements a and c are correct. All of the statements above are correct.

41)

Assume that you are comparing two firms which are identical, with one exception. Firm A is an all-equity firm and firm B has a debt-equity ratio of .6. All else equal, firm A will: a) b) c) d) e) always be more profitable than firm B, since it has no interest expense have a lower EPS than Firm B when the level of earnings before interest and taxes (EBIT) is relatively high have a lower EPS than firm B when the level of EBIT is relatively low generate a higher EBIT, but lower net income than firm B generate a lower EBIT, but higher net income than firm B

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42)

Nature's Escape sponsors outdoor adventures for people of all ages. The company has a cyclical dividend policy and a target payout ratio of .55. The estimated earnings per share for the next year, by quarter, are $1.20, $.20, $1.80, and $1.40, respectively. Nature's Escape anticipates paying: a) b) c) d) e) an annual dividend in the fourth quarter of $2.53 a share an annual dividend in the fourth quarter of $2.07 a share quarterly dividends of $.66, $.11, $.99, and $.77 per share, respectively over the next four quarters quarterly dividends of $.54, $.09, $.81, and $.63 per share, respectively over the next four quarters a quarterly dividend of $.6325 per share for each of the next four quarters

43)

Which of the following statements is most correct? a) b) The optimal capital structure minimizes the WACC. If the after-tax cost of equity financing exceeds the after-tax cost of debt financing, firms are always able to reduce their WACC by increasing the amount of debt in their capital structure. Increasing the amount of debt in a firms capital structure is likely to increase the costs of both debt and equity financing. Statements a and c are correct. Statements b and c are correct.

c) d) e)

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44)

Bryo, Inc., paid quarterly dividends of $.62 a share last year. The company currently has excess cash and would like to distribute $.95 a share to its shareholders this quarter. However, the company is concerned about increasing the dividend as they are unsure if they can afford a $.95 quarterly dividend on an ongoing basis. Management does not want to decrease their dividend once it has been increased. The best form of a dividend payment for this quarter is probably a(n): a) b) c) d) e) special dividend of $.95 a share extra dividend of $.95 a share combined regular and extra dividend in one quarterly payment of $.95 a share combined special and extra dividend in one quarterly payment of $.95 a share stock dividend with a value of $.95 a share

45)

A company has a capital structure that consists of 50 percent debt and 50 percent equity. Which of the following statements is most correct? a) b) c) d) e) The WACC exceeds the cost of equity financing. The WACC can only be calculated on a before-corporate tax basis. The cost of capital from retained earnings exceeds the cost of capital from issuing new common stock. The cost of equity financing is greater than the cost of debt financing. All of the above statements are correct.

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46)

What is the present value of a 5-year deferred annuity with annual payments of $150 if the first payments starts at the end of year 4 and the per annum interest rate is 15%? a) b) c) d) e) $ $ $ $ $ 287.49 330.62 502.83 750.00 969.35

47)

You are an Australian resident taxpayer and you have just received a dividend cheque for $2,100 from Qantas Corporation. The dividend is fully franked and carries franking credits at the corporate rate of tax of 30%. If your personal tax rate is 45 percent in your next tax return you will, as a consequence of this dividend: a) b) c) d) e) Receive a tax refund of $900 Have to pay additional tax of $320 Have to pay additional tax of $450 There are no taxes on fully franked dividends. None of the above.

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48)

Mighty Mack Inc. is analyzing two machines to determine which one they should purchase. The company requires a 14 percent rate of return and uses straight-line depreciation to zero book value. Machine A has a cost of $290,000, annual operating costs of $8,000, and a 3year life. Machine B costs $180,000, has annual operating costs of $12,000, and has a 2year life. Whichever machine is purchased will be replaced at the end of its useful life. Which machine should Mighty Mack purchase and why? (Round your answer to whole dollars) a) b) c) d) e) machine A; because it will save the company about $8,600 a year machine A; because it will save the company about $132,912 a year machine B; because it will save the company about $200,000 a year machine B; because it will save the company about $11,600 a year machine B; because its equivalent annual cost is $199,759

49)

A 10-year bond with a 9 percent semi-annual coupon is currently selling at par. A 10-year bond with a 9 percent annual coupon has the same risk, and therefore, the same effective annual return as the semi-annual bond. If the annual coupon bond has a face value of $1,000, what will be its price? a) b) c) d) e) $ 987.12 $1,000.00 $ 471.87 $1,089.84 $ 967.34

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50)

A public issue of securities which are first offered to existing shareholders is best defined as: a) b) c) d) e) general offer rights offer seasoned offering private placement general cash offer

END

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