Version A

Time allowed: 2 hours

Aids allowed: Closed-book except for an 8 1/2” by 11” crib sheet; a financial calculator is also
allowed

There are 30 multiple choice questions. Answer all multiple-choice questions on the scan sheet.
Only the scan sheet will be graded.

All questions are worth 1 mark each. For questions involving calculations, choose the closest
answer.

There is a bonus question worth 1 mark. Answering it incorrectly will not hurt your

score. Read the questions carefully.

You must submit your crib sheet along with this exam paper and your scan sheet. Please ensure
that your name and student ID are on the cover page of this exam paper.

Good luck!
1. Which version of the exam do you have? This is a free mark – take it. Make sure you answer
it correctly, though.
A) Version A
B) Version B
C) Version C
D) Version D

2. Your firm has a project opportunity with the following cash flows: -$1,200,000 in Year 0,
$150,000 in Year 1, $295,000 in Year 2, $875,000 in Year 3, and $390,000 in Year 4. Your
firm’s WACC is 12%. What would be the discounted payback period of this project assuming
that cash flows from Years 1 to 4 are received equally throughout the year?
A) 2.31 years
B) 3.27 years
C) 3.84 years
D) 4.18 years
E) There is not enough information to answer this question.

Please use the following information to answer the next TWO questions.

A high-tech machine that produces watch bands costs $849,000. This cost could be depreciated at
30% per year (CCA Class 10). The machine would be worth $175,000 in five years. There are no
capital gains to worry about. The new machine would save the firm $262,000 per year before
taxes in operating costs. There is no impact on net working capital. The firm’s WACC is 15% and
the corporate tax rate is 40%.

3. What is the total present value of the after-tax operating cost savings that the machine will
bring?
A) $786,148
B) $878,265
C) $606,003
D) $611,453
E) $526,959

4. Pretend that your answer to the previous question is $600,000. What would be the NPV of
purchasing this system?
A) $37,892
B) $26,439
C) $304,704
D) $32,442
E) $71,124

5. Suppose Firm ABC has a market value of debt equal to $352,000 and a market value of equity
equal to $750,000. What are the capital structure weights of debt and equity, respectively? A)
47.91%; 52.09%
B) 31.94%; 68.06%
C) 52.09%; 47.91%
 D) 68.06%; 31.94%
E) 46.93%; 53.07%

6. Lucron Corp. is considering a project that will cost $310,000 and will generate after-tax cash
flows of $96,000 per year for 5 years. The firm’s WACC is 12% and its target D/E ratio is
2/3. The flotation cost for debt is 4% and the flotation cost for equity is 8%. What would be
the new cost of the project after adjusting for flotation costs?
A) $328,390
B) $329,787
C) $331,197
D) $329,840
E) $290,160

7. When calculating weights for the WACC, it has become relatively common to use Net Debt.
How is Net Debt calculated?
A) Net Debt = Total amount of debt – Cash & Risk-Free Securities
B) Net Debt = Total amount of debt + Cash & Risk-Free Securities
C) Net Debt = Long-term Debt – Short-term Debt
D) Net Debt = Short-term Debt – Long-term Debt
E) Net Debt = Long-term Debt – Short-term Debt + Cash & Risk-Free Securities

Please use the following information to answer the next THREE questions.

LNZ Corp. is thinking about leasing equipment to make tinted lenses. This equipment would cost
$3,400,000 if purchased. The CCA rate on the equipment is 40% and the salvage value after its
five-year life will be $350,000. There are no capital gains to worry about. The firm's corporate tax
rate is 40% and its pre-tax cost of debt is 12%. WeLease Corp. has offered to lease the system to
LNZ for payments of $710,000 per year for five years. These lease payments would be made at
the START of the year. Assume that the tax deductibility benefit of the lease payments occurs at
the same time the lease payments are made.

8. What is the present value of the after-tax lease payments?

A) $1,737,390
B) $2,895,617
C) $1,862,461
D) $1,719,911
E) $2,866,518

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9. Pretend that your answer to the previous question was exactly $2,000,000. If the present value
of the CCA tax shield on the equipment is $1,030,032, what would be the NAL for LNZ? A)
$385,372
B) $122,742
C) $402,831
 D) -$772,875
E) $369,968

10. Now suppose that there are maintenance costs on the equipment of $30,000 per year for five
years (paid at year end). These costs would have to be paid by the firm if they purchase the
equipment, but if they lease it instead, the maintenance costs are already included in the lease
payment. How would these maintenance costs affect the NAL for LNZ?
A) The NAL would decrease by $30,000.
B) The NAL would decrease by $73,410.
C) The NAL would increase by $30,000.
D) The NAL would increase by $73,410.
E) The NAL would not be affected.

Please use the following information to answer the next TWO questions.

Your firm will either purchase or lease a new fabricator. If purchased, the fabricator will cost
$940,000 and be depreciated for tax purposes on a straight-line basis over five years. The
fabricator has no residual value at the end of the five years Your firm can also lease the
fabricator for five years (payments are made at the start of the year). The firm can borrow at 15%
pre-tax. Assume that the tax deductibility benefit of the lease payments occurs at the time the
lease payments are made.

11. If the firm’s corporate tax rate is 40%, what would the before-tax lease payment have to be to
make your firm indifferent between leasing and buying the fabricator?
A) $166,467
B) $254,537
C) $152,722
D) $277,445
E) There is not enough information.

12. Pretend now that your firm pays no taxes, but all other details are as given above. Suppose
the lessor has set the lease payment at $230,000. What would be the NAL for your firm? A)
$53,355
B) $169,004
C) -$239,147
D) -$123,497
E) $345,857

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13. If a firm acquires a $20 million ship through an operating lease, what would happen to the
balance sheet and debt ratios of the firm?
A) The asset and liability amounts would each increase by $20 million, and the debt ratio
would increase.
 B) The asset and liability amounts would each decrease by $20 million, and the debt ratio
would decrease.
C) The asset and liability amounts would each increase by $20 million, and the debt ratio
would decrease.
D) The asset and liability amounts would each decrease by $20 million, and the debt ratio
would increase.
E) There would be no change in the balance sheet or debt ratios of the firm.

Please use the following information to answer the next TWO questions.

Safe-T Corp. has no debt outstanding and a total market value of $4,500,000. The firm is
considering a debt issue of $2,700,000 at an 8% interest rate and will use the funds to buy back
shares in the firm. There are currently 150,000 shares outstanding and there are no taxes in the
economy.

14. If EBIT this year is $750,000, what is the EPS of the firm in the current capital
structure? A) $8.90
B) $5.00
C) $12.50
D) $3.56
E) $7.50

15. What is the breakeven level of EBIT between the two capital
structures? A) $900,000
B) $1,666,667
C) $2,100,000
D) $600,000
E) $360,000

16. Which of the following companies did I use in class when discussing the costs of financial
distress?
A) Porter Airlines
B) Apple
C) Sears Canada
D) Xerox
E) Air Canada

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17. Shopifeye Inc. is debating whether to convert its all-equity capital structure to one that is 40%
debt. There are currently 300,000 shares outstanding and the price per share is $40. EBIT is
expected to remain at $650,000 per year forever. The interest rate on new debt is 6% and it is
a perfect capital market. A potential shareholder of the firm has $6,000 to invest in the
 company. Suppose the firm does not convert but she prefers the proposed capital structure
with debt. What strategy would she use to achieve her desired cash flows?
A) Borrow $10,000 at 6% interest and buy 250 shares in the firm.
B) Borrow $4,000 at 6% interest and buy 250 shares in the firm.
C) Borrow $4,000 at 6% interest and buy 100 shares in the firm.
D) Borrow $6,000 at 6% interest and buy 150 shares in the firm.
E) None of the above.

Please use the following information to answer the next TWO questions.

A firm has an annual EBIT of $50,000 in perpetuity. The firm is unlevered and pays no corporate
taxes. The firm’s shareholders require a 10% return.

18. What is the current value of this firm?

A) $5,000
B) $45,000
C) $450,000
D) $500,000
E) There is not enough information.

19. What would happen to the value of this firm if it decided to add $250,000 of debt at 5%
interest and use the proceeds to buy back shares?
A) The value of the firm would remain unchanged.
B) The value of the firm would decrease by $250,000.
C) The value of the firm would increase by $250,000.
D) The value of the firm would increase by more than $250,000.
E) The value of the firm would decrease by more than $250,000.

20. Your firm is going to borrow $5 million by issuing 20-year bonds. Your firm’s cost of debt is
9% and its tax rate will remain at 40% for at least the next 20 years. By how much does the
interest tax shield increase the value of your firm?
A) $369,706
B) $1,450,924
C) $1,643,138
D) $2,464,707
E) $2,000,000

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Please use the following information to answer the next TWO questions.

Greene Inc. has a required return on assets of 15%, a cost of debt of 8%, and is 35% financed
with debt. There are no corporate taxes.
21. What is the firm’s levered cost of equity?
A) 13.52%
B) 18.77%
C) 15.00%
D) 17.11%
E) 19.31%

22. If the firm were to change its capital structure so that it is financed with 50% debt, what
would be the new WACC?
A) 15.00%
B) 13.38%
C) 16.79%
D) 11.50%
E) None of the above.

Please use the following information to answer the next TWO questions.

Silver Corp. expects an EBIT of $550,000 every year forever. The firm currently has no debt, and
its cost of equity is 20%. The firm is thinking of borrowing $650,000 at 12% and buying back
shares. The corporate tax rate is 40%.

23. What would be the value of the levered firm?

A) $1,650,000
B) $1,910,000
C) $1,260,000
D) $1,390,000
E) $2,750,000

24. What would be the firm’s cost of equity and WACC, respectively, after the
recapitalization? A) 25.78%; 19.46%
B) 29.90%; 22.17%
C) 20.00%; 15.64%
D) 22.48%; 17.28%
E) 21.63%; 16.72%

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25. JKL Corp. is choosing between two capital structures: one is all equity and the other is a mix
of debt and equity. The firm has just calculated that the breakeven EBIT between the two
capital structures is $400,000. If the firm expects its earnings to be $500,000 for the
foreseeable future, which capital structure should the firm choose?
A) They should choose the capital structure with only equity because EPS will be higher.
 B) They should choose the capital structure with equity and debt because EPS will be
higher.
C) They should choose the capital structure with equity and debt because EPS will be
lower.
D) They should choose the capital structure with only equity because EPS will be lower.
E) They are indifferent between the two capital structures.

26. Holy Manure Inc. is currently an all-equity firm with a market value of $49,000,000 and a
stock price of $50 per share. If the firm does a 10-for-7 stock split, what will be the price per
share after the split?
A) $35
B) $50
C) $71.43
D) $65
E) $28.57

27. Your firm is all-equity with 1 million shares outstanding. The firm currently has $80 million
in cash and expects future free cash flows of $18 million per year. Management is deciding
whether to use the cash to either expand the firm’s operations, which will in turn increase
future free cash flows to $25 million per year, or to pay out the cash in a share repurchase. If
the cost of capital of the firm’s investments is 10%, which option would be preferred by
shareholders?
A) Shareholders would prefer the repurchase since the share price will be $7 higher.
B) Shareholders would prefer the expansion since the share price will be $10 higher.
C) Shareholders would prefer the expansion since the share price will be $7 higher.
D) Shareholders would prefer the repurchase since the share price will be $10 higher.
E) Shareholders would be indifferent between the two options.

28. LMN Corp. is going to announce on March 8th that a $4.50 per share dividend will be paid on
May 23rd, to shareholders of record on April 25th. If you want to buy XYZ’s shares and
receive this $4.50 per share dividend, you need to buy XYZ’s shares (at latest) on or before
_________. A) April 23rd
B) March 5th
C) May 20th
D) April 25th
E) April 22nd

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29. AlmostDone Corp. (ADC) is an all-equity firm that will pay a dividend of $21/share next year
and a liquidating dividend of $16 at the end of the 2 nd year. The current stock price is $31.51
per share. Ignore taxes and assume a discount rate of 12%. You own 3,000 shares in ADC. If
you were to use homemade dividends to generate equal dividends over the next two years,
 how many shares would you need to buy or sell at the end of the first year? Assume
fractional shares can be bought and sold. Tip: use two decimal places on per-share dividends
and whole numbers (no decimals) for total dividends.
A) You would need to buy 224.69 shares at the end of the first year.
B) You would need to buy 337.14 shares at the end of the first year.
C) You would need to buy 495.45 shares at the end of the first year.
D) You would need to sell 442.50 shares at the end of the first year.
E) You would need to sell 298.41 shares at the end of the first year.

30. Stock repurchases send a positive signal that management believes that the current stock price
is _________, and the signal is more positive for _________ repurchases than for
__________ repurchases.
A) Undervalued; open market; tender offer
B) Overvalued; open market; tender offer
C) Undervalued; tender offer; open market
D) Overvalued; tender offer, open market
E) None of the above.

BONUS QUESTION

31. In class, I mentioned an example of a company that paid special dividends to its shareholders.
Which company was it?
A) Porter Airlines
B) Microsoft
C) Apple
D) Sears Canada
E) Air Canada

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