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    Review Material - Corporate Finance

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    Juan Frivaldo
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    Review Material - Corporate Finance

    Uploaded by

    Juan Frivaldo
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    16 views3 pages

    Review Material - Corporate Finance

    Uploaded by

    Juan Frivaldo
    p

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    of 3

    Professional School

    PS Building, Matina Campus, Davao City


    Phone No.: (082) 305-0645

    REVIEW MATERIAL – SUMMER 2019

    Problem 1 (CFA, adapted)


    During a 5-year period, the relevant results for the aggregate market are that the risk-free rate is 8
    percent and the return on market is 14 percent. For that period, the results of four portfolio managers
    are as follows:
    Portfolio Manager Ave. Returns (%) Beta
    A 13 0.80
    B 14 1.05
    C 17 1.25
    D 13 0.90

    a. Calculate the expected rate of return for each portfolio manager and compare the actual
    returns with the expected returns.
    b. Based upon your calculations, select the manager with the best performance. You need to
    show your computation.
    c. What are the critical assumptions in the capital asset pricing model (CAPM)?
    d. What are the implications of relaxing these assumptions?

    Problem 2 (adapted)
    Bartling Energy Systems recently reported P9,250 of sales, P5,750 of operating costs other than
    depreciation, and P700 of depreciation. The company had no amortization charges, it had P3,200 of
    outstanding bonds that carry a 5% interest rate, and its federal-plus-state income tax rate was 35%.
    In order to sustain its operations and thus generate sales and cash flows in the future, the firm was
    required to make P1,250 of capital expenditures on new fixed assets and to invest P300 in net
    operating working capital.

    a. By how much did the firm's net income exceed its free cash flow?
    b. What is the importance of knowing the company’s free cash flow?

    Problem 3 (CMA, adapted)


    The treasurer of a new venture, Charmaine Scientific, Inc., is trying to determine how to raise P6
    million of long-term capital. Her investment adviser has devised the alternative capital structures
    shown below:

    Alternative A Alternative B
    P2 million 9% debt P4 million 12% debt
    P4 million equity P2 million equity

    If alternative A is chosen, the firm would sell 200,000 shares of ordinary shares to net P20 per share.
    Shareholders would expect an initial dividend of P1 per share and a dividend growth rate of 7 percent.
    Under alternative B, the firm would sell 100,000 shares of ordinary shares to net P20 per share. The
    expected initial dividend would be P0.90 per share, and the anticipated dividend growth rate 12
    percent.

    Assume that the firm earns a profit under either capital structure and that the effective tax rate is 50
    percent.

    a. What is the cost of capital to the firm under each of the suggested capital structures? Explain
    your result.
    b. Explain the logic of the anticipated higher interest rate on the debt associated with alternative
    B?
    c. Is it logical for shareholders to expect a higher dividend growth rate under alternative B?
    Explain your answer.

    Problem 4 (adapted)
    Honest Company wishes to expand its productive capacity. In order to do so it must acquire a new
    tractor costing P40,000. The machine can be purchased or leased. The firm is in the 40 percent tax
    bracket and its after-tax cost of debt is currently 6 percent.

    If the firm purchased the machine, the purchase would be totally financed with a 10 percent loan
    requiring equal annual end-of-the-year payments over 5 years. The machine would be depreciated
    straight-line over its 5-year life. A salvage value of zero is anticipated. The life of a lease would be 5
    years. The lessor intends to charge equal annual lease payments that will enable it to earn 15 percent
    on its investment. In doing the following calculations, round your answers to the nearest peso.

    a. Calculate the annual lease payment required in order to give the lessor its desired return.
    b. Calculate the annual loan payment paying 10 percent interest.
    c. Determine the after-tax cash outflows associated with each alternative.
    d. Find the present value of the after-tax cash outflows using the after-tax cost of debt?
    e. Which alternative would you recommend? Why?

    Problem 5 (adapted)
    Editha Lee must decide which of two securities is best for her. By using probability estimates, she
    computed the following statistics:

    Statistics Security X Security Y


    Expected return 12% 8%
    Standard deviation 20% 10%

    a. Compute the coefficient of variation for each security.


    b. Explain why the standard deviation and coefficient of variation give different rankings of risk.
    Which method is superior and why?

    Problem 6 (adapted)
    Vanessa Corporation’s sales are expected to increase from P5 million in 2015 to P6 million in 2016, or
    by 20%. Its assets totaled P3 million at the end of 2015. Vanessa Corporation is at full capacity, so its
    assets must grow in proportion to projected sales. At the end of 2015, current liabilities are P1 million,
    consisting of P250,000 of accounts payable, P500,000 of notes payable and P250,000 of accrued
    liabilities. Its profit margin is forecasted to be 5% and the forecasted retention ratio is 30%.

    a. Use the AFN equation to forecast the additional funds Vanessa Corporation will need for the
    coming year.
    b. What additional funds would be needed if the company’s year-end 2015 assets had been P4
    million? Assume that all other numbers are the same. What is this AFN different from the
    one you found in letter “A”? Is the company’s “capital intensity” the same or different?
    Explain.
    c. Assume that the company had P3 million in assets at the end of 2015. However, now assume
    that the company pays no dividends. Under these assumptions, what additional funds would
    be needed for the coming year? Why is this AFN different from the one you found in letter
    “A”? Explain.

    Problem 7 (adapted)
    Mark Honest Corporation currently expects to pay a year-end dividend of P2.00 a share (D1 = P2.00).
    Mark Honest Corporation’s dividend is expected to grow at a constant rate of 5% a year, and its beta
    is 0.9.

    a. What is the current bid price of Mark Honest Corporation’s stock?

    Glenn Company estimates that if it acquires Mark Honest Corporation, the year-end dividend will
    remain at P2.00 a share, but synergies will enable the dividend to grow at a constant rate of 7% a year
    (instead of the current 5%). Glenn Company also plans to increase the debt ratio of what would be its
    Mark Honest subsidiary – the effect of this would be to raise Mark Honest Corporation’s beta to 1.1.

    b. What is the per share value of Mark Honest to Glenn Company?

    c. On the basis of your answer above, if Glenn Company were to acquire Mark Honest
    Corporation, what would be the range of possible prices it could bid for each share of Mark
    Honest ordinary share?

    ---End of the Examination---

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