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Unformatted text preview: BADM 115 – Section 11 Prof. Isabelle Bajeux‐Besnainou Fall 2008 Form B QUIZ #3 1. (4 points) Central City Construction (CCC) needs \$1.5 million of assets to get started, and it expects to have a basic earning power ratio of 30%. CCC will own no securities, so all of its income will be operating income. If it chooses to, CCC can finance up to 60% of its assets with debt, which will have a 7% interest rate. Assuming a 35% tax rate on all taxable income, what is the difference between its expected ROE if CCC finances with 60% debt versus its expected ROE if it finances entirely with common stock? TA = 1,500,000 Int. rate = 7.0% T = 35.0% BEP = 0.3 EBIT = 0.3 * 1500000 = 450,000 Finance with debt D/A = Equity = 1500000 * (1 ‐ 0.6) = Debt = Interest = EBT = Tax = NI = ROE = Difference in ROE = Finance with common stock D/A = Equity = 1500000 * (1 ‐ 0) = Debt = Interest = EBT = Tax = NI = ROE = 0.6 600,000 900,000 63,000 387,000 135,450 251,550 41.9% 22.4% ‐ 1,500,000 ‐ ‐ 450,000 157,500 292,500 19.5% 2. (2 points) Is an initial public offering an example of a primary or a secondary market transaction? Explain. A primary market is the market in which corporations raise capital by issuing new securities. An initial public offering is a stock issue in which privately held firms go public. Therefore, an IPO would be an example of a primary market transaction. 3. (4 points) A company has an EPS of \$5.00, a cash flow per share of \$11.00, and a price/cash flow ratio of 6.0x. What is its P/E? EPS = CFPS = P/CF = P = P/E = \$ 5.00 \$ 11.00 6.0 \$ 66.00 13.2x 6.00 * 11.00 = 66.00 / 5.00 = B ‐ 1 ...
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