OF UNIVERSITY TORONTO
at Scarborough
Management
MGTC09 (Intermediate Finance)
Mid term Exam
Date: March 6, 2009
Total Marks: 100
Time: 3-5 p.m.
Rooms: HW216, SW309, SW319
Prof. Syed W. Ahmed
TAs: David Chen & Evan Huang
Number of Pages including the title page: 8
Items Allowed: Calculator and one 8.5x11 single sided crib sheet. Only handwritten (no
photocopies) crib sheet is allowed
Please do all the problems with pen or at least write the final answer with pen.
You can write on both sides of a page to answer the questions.
STUDENTS NAME:________________________________________________
Last First Middle
STUDENTS I.D. NO.:_______________________________________________
SECTION:
L01 L02 L03 L04
Mon 9-11am Tues 9-11am Mon 1-3pm Tues 2-4pm
Please circle your section
QUESTION NO. MAX. MARKS
MARKS OBTAINED
1 30
__________________
2 25
__________________
3 25
__________________
4 20
__________________
TOTAL MARKS 100
__________________
GOOD LUCK
-2
QUESTION 1:
C09 Enterprises capital consists of perpetual debt with a face value of $100 million and coupon rate of
10% trading at 125% of the face value. It also has 5 million common shares outstanding. Its most
recent dividend was $5. Dividends expect to decline 2% per year, and the required rate of return is
14%. C09 has corporate tax rate of 40% and equity beta of 1.25. Assume risk free rate of 4% and
market risk premium of 8%
C09 is considering the following 3 projects:
Annual before tax Life Project
Project Cost cash flows (in years) Beta
A $28 million $5 million 25 1.1
B $50 million Project will offer an annual after tax rate of return of 12% 1.4
C $50 million $6 million one year from now and after 1.8
that increasing at 4% per year in perpetuity
Which one(s) of the above projects C09 should undertake and why?
-3
-4QUESTION
2:
NoRiskNoGain Manufacturing (NRNG) an all equity firm expects EBIT of $5,000,000 next year, after
that it will grow at 5% per annum. The corporate tax rate is and 40%, cost of unlevered equity is 15%.
NRNG is considering replacing some of the equity with perpetual debt. It has been determined that risk
of bankruptcy is a function of amount of debt. PV of bankruptcy related costs will be $20,000,000.
NRNG is considering the following debt levels.
Debt $15,000,000 $20,000,000 $25,000,000
Probability of Bankruptcy 0.10 0.15 0.35
a.
Determine the optimal level of debt, and the value of the firm at that level.
b.
If personal tax rate on stock income is 30%, and the personal tax rate on bond income is 46% at
what debt level value of the firm be optimal
-5
-6QUESTION
3:
NoHope Technologies (NT) is considering the following two machines for manufacturing widgets.
LL Model SL Model
Expected annual before tax cost savings $8,000 $6,000
Economic Life 8 years 4 years
Price of Machine $15,000 $8,000
Both machines will be worthless at the end of their economic life.
The machines have a CCA rate of 30%. NT is subject to a corporate tax rate of 40%. NT has obtained
the following information for its analysis of various investments and financial proposals:
Expected Covariance with
Asset Return Variance Market Returns
Risk free asset 0.04
Market Portfolio 0.09 0.03
FDT Common Stock 0.045
NT, an all equity firm, has a market value of $10,000,000
a.
What is NTs cost of capital?
b.
Which of the two machines should NT purchase?
c.
NT is considering the sale of $2,000,000 of 6% perpetual bonds and uses the proceeds to
repurchase NT stock. If this plan is adopted:
1.
What is the new value of the firm?
2.
What is the value of the firms equity?
-8QUESTION
4:
Leverage Limited (LL) and More Leverage Limited (MLL) both have the same unlevered equity beta
of 1.2. The equity beta of LL is 1.89 and the equity beta of MLL is 2.05. The corporate tax rate is 40%
for both companies, the expected market risk premium is 6% and the risk free rate of return is 4%.
Assuming that the beta of debt is 0.4, determine the debt/equity ratio for each firm.