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FIN 5405 - Final Exam Topic Review - OEM 2009 Program

# FIN 5405 - Final Exam Topic Review - OEM 2009 Program - FIN...

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FIN 5405 – Final Exam Topic Review – OEM 2009 Program Page 1 FIN 5405 Financial Management OEM 2009 Program Final Exam Topic Review Your final exam consists of 10 true/false questions worth 1 point each and 30 problem- oriented questions worth 3 points each. Below is a list of the general topic for each question, along with some review points that you might wish to be familiar with (some of the points may be more in-depth then actually needed, but are still good points to know). The homework problems (all of them) are a good study source for this exam. Section 1 – True/False Questions – 1 Point Each 1. Capital structure, beta, and risk. The firm’s asset beta (risk of the left-hand side of the balance sheet) is nothing more than a weighted average of the risk on the right-hand side of the balance sheet: β A = ( β D )*(W D ) + ( β E )*(W E ) A firm can change its asset or unlevered beta by changing the risk or composition of its assets. __________ If we assume that the beta of debt is zero, and include taxes, then: β L = [ β u ]*[1 + (D/E)(1-T)] = β e β u = β L / [1 + (D/E)(1-T)] = β A The firm can change its equity or levered beta by changing the amount of debt (financial risk) it has. 2. Modigliani and Miller and capital structure. Without Taxes: V L = V U With Corporate Taxes:

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FIN 5405 – Final Exam Topic Review – OEM 2009 Program Page 2 V L = V U + TD 3. Divisional betas versus corporate-wide beta. The firm’s corporate beta is nothing more that a weighted average of the risk of its divisional betas. A corporation comprised of 2 divisions would be: β C = ( β 1 )*(W 1 ) + ( β 2 )*(W 2 ) 4. Internal rates of return. 5. Additional funds needed. 6. ROA, ROE, and leverage. ROA = (PM)*(TAT) ROE = (PM)*(TAT)*(EM) EM = 1 / (1 - DR) 7. Gordon constant growth model. We went through the development of the constant growth model in class: (1) P 0 = D 0 (1+g) 1 /(1+r) 1 + D 0 (1+g) 2 /(1+r) 2 + … + D 0 (1+g) -1 /(1+r) -1 + D 0 (1+g) /(1+r) Now multiply both sides of Equation 1 by (1+r)/(1+g) to get Equation 2: (2) P 0 (1+r)/(1+g) = D 0 + D 0 (1+g) 1 /(1+r) 1 + … + D 0 (1+g) -2 /(1+r) -2 + D 0 (1+g) -1 /(1+r) -1 Now subtract Equation 1 from Equation 2 P 0 (1+r)/(1+g) - P 0 = D 0 - D 0 (1+g) /(1+r) If we assume that the discount rate is greater than the growth rate , then the last term approaches 0 in the limit and can be discarded, which leaves us with:
FIN 5405 – Final Exam Topic Review – OEM 2009 Program Page 3 P 0 (1+r)/(1+g) - P 0 = D 0 Multiplying through we can rearrange terms as follows: P 0 (1+r) - P 0 (1+g) = D 0 (1+g) P 0 - P 0 + P 0 r -P 0 g = D 0 (1+g) = P 0 (r-g) P 0 = D 0 (1+g)/(r-g) = D 1 /(r-g) Note that this model only works if r > g, since this was a necessary condition for us to assume that the present value of a price an infinite number of time periods in the future was zero. If you try to use this model with r < g, you will get nonsensical results (price less than zero). Also note that if growth is zero, then D

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FIN 5405 - Final Exam Topic Review - OEM 2009 Program - FIN...

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