Sample Final

Sample Final - Practice problems for Final exam FNCE-3010...

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Practice problems for Final exam FNCE-3010 - ANSWERS 1.An investor can create the effect of leverage on his/her account by: A) buying equity of an unlevered firm B) by investing in risk-free debt like T-bills C) by borrowing on his/her own account D) (a) and (c) Answer: D 2.Health and Wealth Company is financed entirely by common stock which is priced to offer a 15% expected return. If the company repurchases 25% of the common stock and substitutes an equal value of debt yielding 6%, what is the expected return on the common stock after refinancing? (Ignore taxes.) Response: r E = r A + (D/E)(r A -r D ) = 15 + (0.25/0.75)(15-6) = 18% 3.MM Proposition II states that: A) The expected return on equity is positively related to leverage B) The required return on equity is a linear function of the firm's debt to equity ratio C) The risk to equity increases with leverage D) All of the above E) None of the above Answer: D 4.For a levered firm, return on equity (r E) ) is equal to: A) r E = r A B) r E = r A + D/E[r A - r D ] C) r E = r A + D/(D+E) [r A - r D ] D) none of the above Answer: D 5.If a firm borrows \$50 million for one year at an interest rate of 9%, what is the present value of the interest tax shield? Assume a 35% tax rate. Response: PV of interest tax shield = ((0.35)*(50)*(0.09))/1.09 = \$1.445 million 6.The Boston Company has total assets of \$30 million, of which \$10 million are financed by debt and \$20 million by equity. The EBIT is \$6 million. If the firm's tax rate is 34%, and the interest rate on debt is 10%, calculate it's after tax cash flow. Response: After tax cash flow = (6-1)(1-0.34) = \$3.3 million 1

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7.Suppose that a company can direct \$1 to either debt interest or capital gains for equity investors. If half of equity income were subject to personal tax (e.g.: half is taxable dividends and half is tax-free capital gains) which investor would not care how the money is channeled? (The corporate tax rate is 35%.) Show your work why you chose this answer. A) Investors paying zero personal tax B) Investors paying a personal tax rate of 52% C) Investors paying a personal tax rate of 17.5% D) None of the above Answer: B 8.Although the use of debt provides tax benefits to the firm, debt also puts pressure on the firm to: A) Meet interest and principal payments which if not met can put the company into financial distress B) Make dividend payments which if not met can put the company into financial distress C) Meet both interest and dividend payments which when met increase the firm cash flow D) Meet increased tax payments thereby increasing firm value Answer: A 9.What are some of the possible consequences of financial distress? A) Debtholders, who face the prospect of getting only part of their money back, are likely to want the company to take additional risks. B)
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Sample Final - Practice problems for Final exam FNCE-3010...

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