NATIONAL UNIVERSITY OF SINGAPORE

FIN3101A CORPORATE FINANCE

Semester 2 (2014/2015) Test 1

14 March 2015 - Time Allowed 2 Hours

_______________________________________________________________________

INSTRUCTIONS TO CANDIDATES
1. This examination paper contains THIRTY (30) multiple choice questions and
comprises NINETEEN (19) printed pages.

2. Tick clearly the most appropriate response on the answer sheets provided on pages 1
and 2. Only answers recorded on the answer sheet will be graded. There is only
ONE (1) correct answer for each question. No penalty for wrong answers.

3. The whole test paper will be collected at the end of the test.

4. The mathematical tables are on pages 13, 14, 15 and 16.

5. You may use pages 17, 18 and 19 for your own workings.

6. You are allowed to bring in an A4 sized, single-sided sheet of notes.

7. Write your full name and tick your class section.

Student Name:

Tick (√) your class section

A1 (Monday 11am-2pm)

A2 (Monday 2-5pm)

A3 (Tuesday 8-11am)
 FIN3101A SEMESTER 2 2014/2015

Tick (√) the most appropriate answer. No penalty for wrong answers.

Question a b c d e
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
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18
19
20

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Tick (√) the most appropriate answer. No penalty for wrong answers.

Question a b c d e
21
22
23
24
25
26
27
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30

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1. A project's operating cash flow will increase when:

a. the depreciation expense increases.
b. the sales projections are lowered.
c. the interest expense is lowered.
d. the net working capital requirement increases.
e. the earnings before interest and taxes decreases.

2. Kurt's Kabinets is looking at a project that will require $80,000 in fixed assets and
another $20,000 in net working capital. The project is expected to produce sales
of $110,000 with associated costs of $70,000. The project has a 4-year life. The
company uses straight-line depreciation to a zero book value over the life of the
project. The tax rate is 35%. What is the operating cash flow for this project?
a. $7,000
b. $13,000
c. $27,000
d. $33,000 sales - cogs- tax -depre = npat
ocf = npat + depre
e. $40,000 hence in this case we ignore depre
Tax = .35 × [$110,000 - 70,000 - ($80,000 ÷ 4)] = $7,000; OCF = $110,000 - $70,000 -
$7,000 = $33,000

3. You are considering two mutually exclusive projects. The incremental IRR for the
investment scenario is _______ and if the required rate is lower than the
crossover rate then project _______ should be rejected

a. 14.79%; A
b. 14.79%; B
c. 17.90%; A
d. 17.90%; B
e. None of the above

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4. The value of a previously purchased building to be used by a proposed project is

an example of a(n)

a. sunk cost.
y not d
b. opportunity cost.
c. erosion cost.
d. fixed cost.
e. None of the above.

5. Thornley Machines is considering a 3-year project with an initial cost of

$618,000. The project will not directly produce any sales but will reduce
operating costs by $265,000 a year. The equipment is depreciated straight-line to
a zero book value over the life of the project. At the end of the project the
equipment will be sold for an estimated $60,000. The tax rate is 34%. The project
will require $23,000 in extra inventory for spare parts and accessories. Should
this project be implemented if Thornley's requires a 9% rate of return? Why or
why not?
a. No; The NPV is -$2,646.00.
b. Yes; The NPV is $27,354.00.
c. Yes; The NPV is $32,593.78.
d. Yes; The NPV is $43,106.54.
e. Yes; The NPV is $196,884.40.
CF0 = -$618,000 + (-$23,000) = -$641,000
Annual depreciation = $618,000 ÷ 3 = $206,000
Taxes = ($265,000 - $206,000) × .34 = $20,060
OCF = $265,000 - $20,060 = $244,940

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C03 = $244,940 + [$60,000 × (1 - .34)] + $23,000 = $307,540

6. Schroeder Electronics is considering a project which will require the purchase of

$5 million in new equipment. The equipment will be depreciated straight-line to a
zero book value over the 5-year life of the project. Schroeder's expects to sell the
equipment at the end of the project for 10% of its original cost. Annual sales from
this project are estimated at $2.3 million. Net working capital equal to 10% of
sales will be required to support the project. All of the net working capital will be
recouped at the end of the project. Schroeder desires a 12% rate of return on this
project. The tax rate is 40%.

What is the amount of the after-tax salvage value of the equipment?

a. $500,000
b. $150,000
c. $195,400
d. $250,000
e. $300,000
After-tax salvage value = $5,000,000 × .10 × (1 - .40) = $300,000

7. Schroeder Electronics is considering a project which will require the purchase of

$5 million in new equipment. The equipment will be depreciated straight-line to a
zero book value over the 5-year life of the project. Schroeder's expects to sell the
equipment at the end of the project for 10% of its original cost. Annual sales from
this project are estimated at $2.3 million. Net working capital equal to 10% of
sales will be required to support the project. All of the net working capital will be
recouped at the end of the project. Schroeder desires a 12% rate of return on this
project. The tax rate is 40%.

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What is the present value of the recovery amount attributable to net working
capital at the end of the project?
a. $130,500
b. $154,600
c. $200,000
d. $230,000
e. $240,000
PV of NWC recapture = .10 × $2,300,000 / 1.12^5 = $230,000 /1.12^5 = 130,508

8. You have been asked to evaluate two pollution control devices. The sand-based
filter costs $100 to set up and $50 per year to operate. It must be completely
replaced every 3 years, and it has no salvage value. The membrane-based filter
device costs $200 to set up and $30 per year to operate. It lasts for 5 years and
has no salvage value. Assuming that pollution control equipment is replaced as
it wears out, which device would you recommend if the cost of capital is 10%?

a. Membrane filter, the EAC is $ 11.00.

b. Sand-based filter, the EAC is $ 90.21.
c. Membrane filter, the EAC is $ 82.76.
d. Sand-based filter, the EAC is $ 9.79.
e. Membrane filter, the EAC is $124.34.

-100-50/1.1- 50/(1.1)2-50/(1.1)3=-224.24 EAC=90.21

-200-30/1.1- 30/(1.1)2-30/(1.1)3-30/(1.1)4-30/(1.1)5=-313.72EAC=82.76

9. A project has an accounting break-even point of 2,000 units. The fixed costs are
$4,200 and the depreciation expense is $400. The projected variable cost per
unit is $23.10. What is the projected sales price?
a. $20.80
b. $21.00
c. $21.20
d. $25.40
e. $25.60
Accounting break-even Q = 2,000 = ($4,200 + $400) ÷ (P - $23.10); P = $25.40

10. Your firm is considering a project with a five-year life and an initial cost of
dk $120,000. The discount rate for the project is 12%. The firm expects to sell 2,100
units a year. The cash flow per unit is $20. The firm will have the option to

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abandon this project after three years at which time it expects it could sell the
project for $50,000. At what level of sales should the firm be willing to abandon
this project?
a. 420 units
b. 1,041 units
c. 1,479 units
d. 1,618 units
e. 2,500 units

11. Quirk and Company has been busy analyzing a new product. It has determined
that an operating cash flow of $18,500 will result in a zero net present value,
which is a company requirement for project acceptance. The fixed costs are
$14,000 and the contribution margin is $8.00. The company feels that it can
realistically capture 10% of the 40,000 unit market for this product. Should the
company develop the new product? Why or why not?
a. No; because 4,000 units of sales is less than the quantity required for a
zero net present value
b. No; because the internal break-even point is greater than 4,000 units
c. Yes; because the firm can generate sufficient sales to obtain at least a
zero net present value
d. Yes; because the project has an expected internal rate of return of 100%
e. Yes; because the project will pay back on a discounted basis
f.
Total CM = 4000 * $8 = $32000. $32000 - $14000 = $18000 < $18500, which gives NPV=0

12. The Webster Corp. is planning construction of a new shipping depot for its single
manufacturing plant. The initial cost of the investment is $1 million. Efficiencies
from the new depot are expected to reduce costs by $100,000 forever. The
corporation has a total value of $60 million and has outstanding debt of $40
million. What is the NPV of the project if the firm has an after tax cost of debt of
6% and a cost equity of 9%?
a. $428,571
b. $444,459
c. $565,547
d. $1,000,000
e. None of these is the correct NPV.
WACC = (40/60)*(.06) + (20/60)*(.09) = .07
NPV = (100,000/.07) - 1,000,000 = $428,571.43

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13. Anderson's Furniture Outlet has an unlevered cost of capital of 10%, a tax rate of
34%, and expected earnings before interest and taxes of $1,600. The company
has $3,000 in permanent bonds outstanding that have an 8% coupon and pay
interest annually. The bonds are selling at par value. What is the cost of equity?
a. 8.67%
b. 9.34%
c. 9.72%
d. 9.99%
e. 10.46%
VU = [EBIT × (1 - Tc)] ÷ RU = [$1,600 × (1- .34)] ÷ .10 = $10,560
VL = VU + (Tc × D) = $10,560 + (.34 × $3,000) = $11,580
VL - VD = VE = $11,580 - $3,000 = $8,580
RE = RU + (RU - RD) × D/E × (1 - TC) = .10 + [(.10 - .08) × ($3,000 ÷ $8,580) × (1 -
.34)] = .10 + .00462 = .10462 = 10.46%

14. Alexandria's Dance Studio is currently an all equity firm that has 60,000 shares of
stock outstanding with a market price of $24 a share. The current cost of equity is
11% and the tax rate is 40%. Alexandria is considering adding $2 million of debt
with a coupon rate of 7% to her capital structure. The debt will be sold at par
value. What is the levered value of the equity?
a. $.12 million
b. $.24 million
c. $1.12 million
d. $2.24 million
e. $2.84 million
VL = (60,000 × $24) + (.40 × $2m) = $1.44m + .80m = $2.24; VE = $2.24m - $2m
= $0.24m

Compare Q4 of Tut 2
Mehta International is an all-equity firm that generates EBIT of $3 million per
year.The cost of equity capital is 16% and its marginal tax rate is 35%.
a. What is the market value of Mehta International?
b. If Mehta now issues $4 million of debt, what is the market value of the
firm? The market value of the stock?

EBIT  (1- Tc) $3m  (1 35%)

(a) Market value of firm VU    $12.1875m
R0 16%

(b) MV of levered firm VL = VU + TcB

  + 4m x 35% = $13.59m
= $12.19m

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MV of Stock = MV of firm – MV of debt

= $13.59m – 4m = $9.59m

15. The free cash flow hypothesis states:

a. that firms with greater free cash flow will pay more in dividends
reducing the risk of financial distress.
b. that firms with greater free cash flow should issue new equity to force
managers to minimize wasting resources and to work harder.
c. that issuing debt requires interest and principal payments reducing the
potential of management to waste resources.
d. Both that firms with greater free cash flow will pay more in dividends
reducing the risk of financial distress; and that issuing debt requires
interest and principal payments reducing the potential of management
to waste resources.
e. Both that firms with greater free cash flow should issue new equity to
force managers to minimize wasting resources and to work harder;
and that issuing debt requires interest and principal payments
reducing the potential of management to waste resources.

16. You have a $1,000 portfolio which is invested in stocks A and B plus a risk-free
asset. $400 is invested in stock A. Stock A has a beta of 1.3 and stock B has a
beta of .7. How much needs to be invested in stock B if you want a portfolio beta
of .90?
a. $0
b. $268
c. $482
d. $543
e. $600
BetaPortfolio = .90 = ($400 ÷ $1,000 × 1.3) + ($x ÷ $1,000 × .7) + (($600 - x) ÷
$1,000 × 0) = .52 + .0007x + 0; .0007x = .38; x = $542.86 = $543

17. GenLabs has been a hot stock the last few years, but is risky. The expected
returns forGenLabs are highly dependent on the state of the economy as follows:

The standard deviation of GenLabs returns is

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a. .0428
b. .2069
c. .3065
d. .3358
e. None of the above
.05(-.50 - .125)2 + .1(-.15 - .125)2 + .2(.05 - .125)2 + .3(.15 - .125)2 + .2(.25 - .125)2 + .15(.40 - .125)2 = .0428
Square root of (.0428) = .2069

18. Alabaster Incorporated has an equity cost of capital of 14%. The debt to value
ratio is .6, the tax rate is 35%, and the cost of debt is 8%. What is the cost of
dk equity if Alabaster was unlevered?
a. 9.05%
b. 10.55%
c. 11.03%
d. 12.55%
e. None of these.
.14 = r0 + (.6/.4)*(r0 - .8)*(.65)
r0 = .1103 = 11.03% get 1st line cant cal 2nd line

19. Empirical evidence suggests that upon announcement of a new equity issue,
current stock prices generally:
a. drop, perhaps because the new issue reflects management's view that
common stock is currently overvalued.
b. remain about the same since an efficient market anticipates a new
equity issue.
c. increase, perhaps because the issues are associated with positive
NPV projects.
d. increase, because the market supply is always less than demand.
e. increase, because underwriters exercise their green shoe option.

20. Evidence on stock prices finds that the sudden death of a chief executive officer
causes stock prices to fall and the sudden death of an active founding chief
executive officer causes stock price to rise. This contrary evidence happens
because:
a. markets are inefficient and unsure of the real value of the events.
b. death is inevitable and market prices are random.
c. things simply happen.
d. the value of the founding executive was a negative to the firm.
e. None of these.

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21. Studies of the performance of professionally managed mutual funds find that
these funds:
a. do not outperform a market index. Assuming mutual fund managers
rely primarily on public information, this finding refutes the semistrong
form of the efficient market hypothesis.
b. do not outperform a market index. Assuming mutual fund managers
rely primarily on public information, this finding supports the
semistrong form of the efficient market hypothesis.
c. outperform a market index. Assuming mutual fund managers rely
primarily on public information, this finding refutes the semistrong form
of the efficient market hypothesis.
d. outperform a market index. Assuming mutual fund managers rely
primarily on public information, this finding supports the semistrong
form of the efficient market hypothesis.
e. Both outperform a market index. Assuming mutual fund managers rely
primarily on public information, this finding refutes the semistrong form
of the efficient market hypothesis; and outperform a market index.
Assuming mutual fund managers rely primarily on public information,
this finding supports the semistrong form of the efficient market
hypothesis.

22. Miller Mfg. is analyzing a proposed project. The company expects to sell 13,000
units, plus or minus 4 percent. The expected variable cost per unit is $7.00 and
the expected fixed cost is $35,000. The fixed and variable cost estimates are
considered accurate within a plus or minus 5 percent range. The depreciation
expense is $33,000. The tax rate is 34 percent. The sale price is estimated at
$13.00 a unit, give or take 3 percent.
What is the net income under the worst case scenario?
a. $-5,500.97
b. $-5,721.01
c. $-5,776.02
d. $-4,105.20 ( P - VC * Q - FC - depre ) * tax
e. $-2,709.43 (13k*.97 -7*1.05 * 13k*.96 - 35k*1.05 - 33k) *0.66
Net incomeworst = (([($13.00 x .97) – ($7.00 x 1.05)] x (13,000 x .96)) – ($35,000 x 1.05) –
$33,000) (1 – .34) = $-2,709.43

23. Stellar Plastics is analyzing a proposed project. The company expects to sell
13,000 units, give or take 4 percent. The expected variable cost per unit is $8.00
and the expected fixed cost is $35,000. The fixed and variable cost estimates are
considered accurate within a plus or minus 6 percent range. The depreciation
expense is $33,000. The tax rate is 34 percent. The sale price is estimated at
$15.00 a unit, give or take 5 percent.
What is the operating cash flow for a sensitivity analysis using total fixed costs of
$32,000?
a. $50,160.00

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b. $17,160.00
c. $26,000.00
d. $14,160.00
e. $59,000.00
OCF = [(13,000 x ($15.00 – $8.00)] – $32,000][1– .34] +($33,000 x .34) = $50,160.00

24. The Meldrum Co. is analyzing a proposed project. The company expects to sell
3,000 units, give or take 15%. The expected variable cost per unit is $8 and the
expected fixed costs are $12,500. Cost estimates are considered accurate within
a plus or minus 5% range. The depreciation expense is $4,000. The sale price is
estimated at $18 a unit, give or take 2%. The company bases its sensitivity
analysis on the expected case scenario.
What is the amount of the fixed cost per unit under the pessimistic case
scenario?
a. $4.17
b. $4.66
c. $5.15
d. $5.35
e. $6.02
Fixed cost per unit for the worst case = ($12,500 × 1.05) ÷ (3,000 × .85) = $5.15

25. Comparing two otherwise equal firms, the beta of the common stock of a levered
firm is ____________ than the beta of the common stock of an unlevered firm.
a. equal to
b. significantly less
c. slightly less
d. greater
e. None of the above

B
 equity  unlevered firm  (1  TC )( unlevered firm   Debt )
S
26. Jack's Construction Co. has 80,000 bonds outstanding that are selling at par
value. Bonds with similar characteristics are yielding 8.5%. The company also
has 4 million shares of common stock outstanding. The stock has a beta of 1.1
and sells for $40 a share. The U.S. 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?
a. 7.10%
b. 7.39%
c. 10.38%
d. 10.65%

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e. 11.37%
Re = .04 + (1.1 × .08) = .128
Debt: 80,000 × $1,000 = $80m
Common: 4m × $40 = $160m
Total = $80m + $160m = $240m

dk this 27. Greenmark receives news that the Economic development Board (EDB) will
provide the company with 5-year bullet loan of $300,000 at 5% interest to reward
its efforts to go green. If Greenmark were to borrow from the bank, the rate would
have been 8%. What is the total added value of debt financing to Greenmark if
their tax rate is 17%

ovifa =cf on calcautor a. $10,181

b. $46,116
cf0 -300k
c01 12450 c. $49,709
f01 4 d. $85,644
co2 312450
fo2 1 e. None of the above
npv i 8 afterwards click down
npv cpt
cpt NPV of loan
= $300,000 – (1 –0.17)(0.05)($300,000)PVIFA8%,5 – [300,000/(1.08)^5]
46116 = 300,000- 12,450 PVIFA – 204,174.96
=300,000- 49,709.24 – 204,174.96
=46,115.80

28. If company A, a medical research company, makes a new product discovery and
their stock rises 5%, this will have:
a. no effect on Company B's, a newspaper, stock price because it is a
systematic risk element.
b. no effect on Company B's, a newspaper, stock price because it is an
unsystematic risk element.
c. a large effect on Company B's, a newspaper, stock price because it is
a systematic risk element.
d. a large effect on Company B's, a newspaper, stock price because it is
an unsystematic risk element.
e. None of these.

29. Suppose that we have identified three important systematic risk factors given by
exports, inflation, and industrial production. In the beginning of the year, growth
in these three factors is estimated at -1%, 2.5%, and 3.5% respectively. As it

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turned out, actual growth in these factors turned out to be as expected. The
factor betas are given by βEX = 1.8, βI = 0.7, and βIP = 1.0. The expected return
on the stock is 6%.
If the company announces that they had an industrial accident and the operating
facilities will close down for some time thus resulting in a loss by the company of
7% in return, what is the stock's total return?
a. -1.00%
b. 1.55% dont understand
if company doesnt produce it should reduce 7%
c. 2.55%
d. 6.00%
e. 7.00%
R = (6%-7%) + 1.8(0) + 0.7(0) + 1(0) = -1.0%

30. Suppose a Miller equilibrium (where there is no gain from leverage) exists with a
corporate tax rate of 30% and a personal tax rate on interest income of 35%.
What is the personal tax rate on dividend income?
a. 0.0%
b. 7.1%
c. 10.05%
d. 45.5%
e. None of the above

0 = {1 - ((1 - .3)(1 - Ts))/(1 - .35)] = Ts = .071 = 7.1%

dont get this

 (1  TC )  (1  TS ) 
VL  VU  1  B
 1  T B 

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You may use this page for your own working

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You may use this page for your own working

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You may use this page for your own working

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