Unformatted text preview: Faculty of Economics and Business Administration Multiple Choice Version B Exam: Corporate Finance 2.5 Student ID: Code: E_EBE2_CF Name: Examinator: Jan Schnitzler Co‐reader: Leonard Wolk Date: July 7, 2017 Time: 12:00 Duration: 2 hours Calculator allowed: Yes Graphical calculator allowed: No Number of questions: 14 Type of questions: Multiple Choice/Open Questions Answer in: English only Remarks: This is a closed book exam. Mark your answers to multiple choice (MC) questions on the separate MC‐answering form. Only one answer is correct (a, b, c, or d). For questions 9‐11, only write your final result in the assigned space (for percentages report two digits after the decimal point). Regarding open questions 12‐14, write your answers into the indicated spaces and make sure that it is legible. You may use disposable sheets for preliminary notes if necessary. Credit score: The maximum number of points that can be reached is 100. Since guessing in MC questions gives 2/8 correct answers in expectation, this part of the exam includes an adjustment factor. Therefore, you can obtain a maximum score of 36 MC points even though there are 8 MC questions. Grades: July 21, 2016 Inspection: to be announced on blackboard Number of pages: 12 (including front page) Good luck! 1 Question 1 (6 points, Multiple Choice): Which statement about the tax treatment of true‐tax leases and non‐tax leases is false? Hint: true‐tax leases largely overlap with operating leases, while non‐tax leases largely overlap with capital leases. a. In a true‐tax lease the lessor depreciates the asset. b. In a true‐tax lease the lessor recognizes lease payments as revenue. c. In a non‐tax lease the lessor depreciates the asset. d. In a non‐tax lease the lessor recognizes the interest portion of lease payments as interest income. Question 2 (6 points, Multiple Choice): Which of the following statements about bond covenants is false? a. Limiting the issuance of additional debt with equal or higher seniority helps to maintain the credit rating of a bond. b. Limiting mergers and other significant control changes helps bondholders to mitigate the Risk Shifting problem. c. Restricting leasing activity secures bondholders from the Debt Overhang problem. d. Limiting distributions via dividends or share repurchases secures bondholders from expropriating wealth transfers. Question 3 (6 points, Multiple Choice): Which of the following statements is correct? a. A widespread use of valuation multiples based on peers provides the advantage that it works against the mispricing in markets if entire industries are under‐ or overvalued. b. Entrenchment refers to managerial actions that make the incumbent manager indispensable to the firm. c. A firm is said to use aggressive working capital management if it finances temporary working capital needs with long‐term financing sources. d. The obligation to pay interest under debt financing aggravates agency conflicts between managers and shareholder. Question 4 (6 points, Multiple Choice): Which company is least likely to be in need of external equity financing. a. A company with increasing economies of scope. b. A company requiring large initial capital expenditures. c. A company with decreasing returns to scale. d. A company with few tangible assets. 2 Question 5 (6 points, Multiple Choice): Which of the following statements is false? a. The Enterprise value/sales ratio is the most popular multiple to value young start‐up firms with negative earnings. b. The Enterprise value/EBITDA multiple remains unaffected if comparable firms use different depreciation policies. c. The Price‐to‐book value is a useful metric for companies with mainly tangible assets. d. The Price/Earnings multiple is particularly useful to value companies with different capital structures. Question 6 (6 points, Multiple Choice): Assume perfect capital markets without corporate taxes. Which of the following variables can be subject to a change due to the repurchase of stock financed with the issuance of new debt? a. The share price. b. The price/earnings ratio. c. The company’s unlevered cost of capital. d. None of the above. Question 7 (6 points, Multiple Choice): Assume perfect capital markets without corporate taxes. How does the cost of debt for a risky project vary with increasing leverage ratios? a. The cost of debt is flat. b. The cost of debt is constantly decreasing. c. The cost of debt is constantly increasing. d. The cost of debt may be flat for low debt levels, but is constantly increasing for high leverage ratios. Question 8 (6 points, Multiple Choice): Which of the following statements describes a consistent un‐levering formula if a firm maintains a financial policy with a predetermined fixed amount of debt? a. b. c.
1 d. All of the above statements are correct. 3 Question 9 (6 points, Open Question): Analysts forecast VUDU Enterprise’s free cash flow for the next fiscal year at $85M. The company has outstanding debt of $120M and intends to increase this level to 136M at the end of the period. Assume that the cost of debt remains unchanged at 6% and that the relevant tax rate is 40%. What is the free cash flow to equity? Answer: ________ Question 10 (6 points, Open Question): Your company maintains a fixed debt‐to‐value ratio and intends to increase this ratio from 40% to 50%. Under the current capital structure, the company has (after‐tax) weighted average cost of capital of 12%. The firm’s borrowing cost remains unaffected through the change in policy at 6%, and the corporate tax rate is 25%. Estimate the company’s (after‐tax) weighted average cost of capital under the new capital structure. Answer: ________ Question 11 (6 points, Open Question): Your firm has 10 million shares outstanding, and you are about to issue 8 million new shares in an IPO. The IPO price has been set at $24 per share, and the share price rises to $36 the first day of trading. Assume that the post‐IPO valuation reflects a fair market value and that there are no underwriting costs. What is a fair stock price if there were no IPO underpricing? Answer: ________ Question 12 (15 points, Open Question): a. List and briefly explain five variables that describe characteristics of boards of directors. 4 b. Explain why the advising and monitoring roles of the board of directors may be in conflict with each other. 5 c. What is the difference between single‐tier and two‐tier boards? d. Briefly explain Dutch employee co‐determination. 6 Question 13 (15 points, Open Question): Consider a one‐period model with an all‐equity firm that is run by a manager who acts in the best interest of existing shareholders. The value of the firm’s assets in place is either $20M or $120M. Suppose that there is asymmetric information: while the manager knows the true value of the assets in place, investors consider both possibilities equally likely. The firm has an investment opportunity that requires an investment of $25M. If successful, the new project generates a cash flow of $50M next period. Otherwise, it is written off. The success probability of the project is 60% and does not depend on the value of assets in place, i.e. also managers don’t know the realization of the new project. Everyone is risk‐neutral and there is no discounting. a. Compute the expected value of the new investment opportunity. Is it NPV positive? b. Assume the only way to finance this project is by issuing equity to new investors in a competitive stock market. Suppose that investors believe that the manager always issues equity, regardless of the true value of assets in place. What fraction of the firm’s equity has to be issued to raise $25M? Does a manager want to issue equity if assets in place are worth $120M? 7 c. Consider the same setup as in part b). What should investors conclude if the manager agrees to issue equity? Would they demand a different fraction α of the firm’s equity to provide financing? d. Suppose the firm can also issue risk‐free debt to raise funds. What is the maximum amount of risk‐free debt that a firm can credibly issue? 8 e. Given the debt amount computed in part d), the firm considers a mixed financing strategy: partially risk‐free debt and the remainder in equity (risky debt is not available). What fraction of the firm’s levered equity has to be issued to raise the remaining amount? Does a manager want to issue equity if assets in place are worth $120M? Compare your finding to part b) and explain. Hint: if you did not solve part d), solve this part with a fictitious amount of debt. Question 14 (16 points, Open Question): ABC Corp. is a private company. XYZ Inc. is a publicly traded firm with a fundamental business risk very similar to the business risk of ABC. XYZ has 40 million shares outstanding. Its current share price is $5, and it has an equity beta of 1.8. XYZ rebalances its capital structure and maintains a constant debt‐to‐value ratio (D/(D+E)) of 1/3. The corporate tax rate for both companies is 35%, the risk‐free rate is 3% and the market risk premium is 6%. The debt of XYZ is risk‐free. a. What is XYZ’s asset beta? And what are ABC’s unlevered cost of capital? 9 The EBITDA of ABC is $320 million per year. The firm has an annual depreciation expense of $80 million per year, and capital expenditures of $80 million per year. You expect these numbers to remain constant in perpetuity. (The firm will have no amortization or changes in net working capital.) b. Compute the free cash flows. c. ABC maintains a constant debt‐to‐value ratio of 0.5. Like XYZ, ABC’s debt is risk‐free. What is ABC’s levered value? What is the present value of tax shields? 10 d. Suppose that ABC also manages a large cash account of $200M aside its main operations. Assume that the company invests the cash in treasury securities at the risk‐
free rate and intends to hold the position in perpetuity. What is ABC’s total value, including operating and financial income? Compare your result to part c) and explain your findings. Extra Space (Please indicate exercise): 11 12 ...
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