Sample CF Final Examination

Question 1: Explain the stock price behavior on the ex-dividend date and why that happens.
Question 2:
a) Explain the reasons for the stock price behavior on the announcement of a Seasoned Equity
Offering.
b) Compare difference between Firm Commitment and Best Effort.
c) ABC corporation is attempting to raise $7,800,000 in new equity with a rights offering.
The subscription price will be $41.5 per share. The stock currently sells for $48 per share
and there are 250,000 shares outstanding. What is the value of a right?
Question 3: The Myers Inc. is considering the purchase of a new machine for $34,500 . The
machine is expected to save the firm $12,800 per year in operating costs over a 5-year period, and
can be depreciated on a straight-line basis to a zero salvage value over its life. Alternatively, the
firm can lease the machine from Stuart Leasing Company for $6,700 per year for 5 years, with the
first payment due in 1 year. The Myers' tax rate is 25% and the before-tax cost of debt is 9%. The
tax rate of Stuart Leasing is 36%.
a) Using NPV analysis, should Myers lease or buy the machine?
b) Calculate the maximum lease payment that Myers can pay.
c) Calculate the break-even lease payment for Stuart Leasing.
Question 4:
Baking Inc. and Sweet Co. are all-equity firms. Baking Inc. has 97,100 shares of stock outstanding
at a price of $40 a share. Sweet Co. has 64,100 shares of stock outstanding at a price of $29 a
share. Baking Inc. is analyzing the possible acquisition of Sweet Co. Baking Inc. believes the
acquisition will increase its total after-tax annual cash flow by $73,500 indefinitely. The
appropriate discount rate for the incremental cash flows is 20 percent.
a) Baking Inc. is acquiring Sweet Co. for $2,030,000 in cash. What is the NPV of the acquisition?
What is the new share price of the merged firm after the acquisition?
b) Suppose stock consideration is used (Baking Inc. offers to pay Sweet Co. in stock). Sweet Co.
is acquired for the $2,000,000 value of Baking’s stock. What is the new share price of the merged
firm after theacquisition? What is the NPV of the acquisition? Should Baking Inc. pay in cash or
stock?
Question 1: An individual purchasing the security before the ex-dividend date will receive the
dividend, whereas another individual purchasing the security on or after this date will not receive
the dividend. And everyone knows this information, so the stock price will adjust down
immediately on the ex-dividend date to avoid investors buying a lot of shares just before the ex-
dividend date to receive dividends and immediately sell off stocks after the ex-dividend date.
Question 2:

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 a) Shareholders who are not inside the company or investors may think that the company's
management decided to issue more shares because they know their company's shares are
overvalued. It is possible that the company is in a period of financial difficulty, or the risk of
financial difficulty is increasing (the company is heavily indebted or is experiencing liquidity
problems) so the ability to raise the company's capital through debt becomes more difficult than
issuing new shares. All the above inferences lead to the market tending to react negatively to
information about SEOs, leading to a drop in stock prices.
b)
Firm Commitment Best Effort
Underwriter is obligated to buy all the shares of the Underwriter make their “best effort” to sell the securities
company and sell them in the IPO processes. at an agreed-upon offering price
The underwriter bears the risk of not being able to sell The issuing company bears the risk of the issue not being
the entire issue for more than the cost. sold.

The underwriter makes money on the spread between Underwriter earns commission fees for selling the shares
the price paid to the issuer and the price received from in an IPO.
investors when the stock is sold.

c)
Number of new shares: 7,800,000/41.5 = 187,951.8072 shares.
The number of rights needed to buy one share will be the current shares outstanding divided
by the number of new shares offered, so:
Number of rights needed: 250,000/187,951.8072 = 1.33
A shareholder can buy 1.33 rights on shares for: 1.33 × $48 = $63.84
The shareholder can exercise these rights for $41.5, at a total cost of:
$41.5 + $63.84 = $105.34
The investor will then have:
Ex-rights shares: 1 + 1.33 = 2.33
The ex-rights price per share is: 𝑃𝑥 = (1.33($48) + $41.5)/2.33 = $45.21
So, the value of a right is: $48 − $45.21 = $2.79
Question 3:
a) After-tax cost debt is 9% × (1 − 25%) = 6.75%
Cashflow - Buying
Year 0 Each Year from 1 to 5
Cost of Machine −34,500
After-Tax Saving 12,800 × (1 − 25%) = 9,600
Depreciation Tax Shield (34,500/5) × 25% = 1,725
Cash Flow −34,500 9,600 + 1,725 = 11,325

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 Cashflow - Lease
Year 0 Each Year from 1 to 5
Lease Payment −6,700 × (1 − 25%) = −5,025
After-Tax Saving 12,800 × (1 − 25%) = 9,600
Cash Flow 9,600 − 5,025 = 4,575

Cashflow of Lease instead of Buy

Year 0 Each Year from 1 to 5
Cash Flow 0 − (−34,500) = 34,500 4,575 − 11,325 = −6,750

NPV of Leasing instead of Buying:

1 1
𝑁𝑃𝑉 = 34,500 − 6,750 × ( − ) = 6,637.42
6.75% 6.76% × (1 + 6.75%)5
Because the NPV of leasing instead of buying is positive so that Myers should lease.
b)
Year 0 Each Year from 1 to 5
Cost of Machine (did not buy) 34,500
Lost Depreciation Tax Shield −6,900 × 25% = −1,725
After-tax Lease Payment −𝐿𝑚𝑎𝑥 × (1 − 25%) = −0.75𝐿𝑚𝑎𝑥
Cash Flow 34,500 −1,725 − 0.75𝐿𝑚𝑎𝑥

The highest lease payment that Myers can pay is:

1 1
𝑁𝑃𝑉 = 0 = 34,500 + (−1,725 − 0.75𝐿𝑚𝑎𝑥 ) × ( − )
6.75% 6.75% × (1 + 6.75%)5
𝐿𝑚𝑎𝑥 = $8,843.98
c)
Year 0 Each Year from 1 to 5
Cost of Machine −34,500
Depreciation Tax Shield 6,900 × 36% = 2,484
After-tax Lease Payment 𝐿𝑚𝑖𝑛 × (1 − 36%) = 64%𝐿𝑚𝑖𝑛
Cash Flow −34,500 2,484 + 0.64𝐿𝑚𝑖𝑛

The break-even lease payment for Stuart Leasing is:

1 1
𝑁𝑃𝑉 = 0 = −34,500 + (2,484 + 0.64𝐿𝑚𝑖𝑛 ) × ( − )
6.75% 6.75% × (1 + 6.75%)5

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 𝐿𝑚𝑖𝑛 = $9,178.09

Question 4:
The Incremental value from acquisition:
73,500
∆𝑉 = = $367,500
20%
a)
The NPV of cash acquisitions:
= 𝑉𝑠∗ − 𝑐𝑎𝑠ℎ𝑝𝑎𝑖𝑑 = (𝑉𝑠 + ∆𝑉) − 𝑐𝑎𝑠ℎ𝑝𝑎𝑖𝑑
= (64,100 × 29 + 367,500) − 2,030,000 = $196,400
Value of the combined firm:
𝑉𝐵𝑆 = 𝑉𝐵 + (𝑉𝑠∗ − 𝑐𝑎𝑠ℎ𝑝𝑎𝑖𝑑) = 97,100 × 40 + 196,400 = $4,080,400
Number of shares of outstanding after the acquisition = Number of shares of Banking Inc. = 97,100
New price per share after acquisition:
𝑉𝐵𝑆 4,080,400
= = = 42.02
Number of shares of outstanding after the acquisition 97,100
b)
Value of combined firm:
𝑉𝐵𝑆 = 𝑉𝐵 + 𝑉𝑠∗ = 𝑉𝐵 + 𝑉𝑠 + ∆𝑉 = 97,100 × $40 + 64,100 × $29 + $367,500 = $6,110,400
Number of new shares Banking Inc. must issue and give to the target’s shareholders:
2,000,000
= = 50,000 𝑠ℎ𝑎𝑟𝑒𝑠
40
Number of shares outstanding after the acquisition: 50,000 + 97,100 = 147,100 shares
Price per share after acquisition:
𝑉𝑆𝑆𝐶𝐿 6,110,400
= = = $41.53
Number of shares of outstanding after the acquisition 147,100
Purchase price is:
6,110,400
= 50,000 × = $2,076,954.453
147,100
NPV of stock acquisition:

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 = 𝑉𝑠∗ − 𝑃𝑢𝑟𝑐ℎ𝑎𝑠𝑒 𝑃𝑟𝑖𝑐𝑒 = (64,100 × $29 + 367,500) − $2,076,954.453 = $149,445.547
Because the NPV of cash acquisition is higher than the NPV of stock acquisition, Banking Inc
should pay in cash.

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