Test_2_Soln - SOLO/76w wfiiéiiibo /_,_,__,,/ University...

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Unformatted text preview: SOLO/76w wfiiéiiibo /_,_,__,,/ University of Waterloo Tenn Test #2 ACTSC 372 — Corporate Finance 2 Instructor: Peter Wood DatezJuh/IOm.2009 Time: 3:30 pm. Duration: 50 minutes Number of Pages: 8 (including cover page and blank page) EXids: (TaICLHalor. Name: ID#: FOR EXAMiNnRs‘ USE ONLY Question Mark 1 /7 2 /S 3 /5 4 /8 5 /4 6 /2 TOTAL /30+1 :1 CTSC 3 "’3 Spring 2009 Term Test #3 Answer in the spaces provided. Show your work [7] l. (a) State and briefly describe the three forms of the efficient market hypothesis (EMH). (AJch —- (rt/CS [rye/te a” [0057! FHCc - W/Umue Null). Jam—SW — fared pL/fu/ oZ/ lgu/o/IL M14) - /0rt'ccr a// hug — pug/ll 0r [Dr/Dale. (b) Historical evidence of the performance ofmutual fund managers shows that on average. the returns ofthe typical fund underperform a comparable index by about 2%. Briefly discuss how this evidence supports (or not) the various forms of the EMH. Why might the average returns systematically Linderperfm'm the index? EULF Mice vaflnél 5W1"4S‘A’w8. FW/J Can/dual Wow Med/I/ vase] cam} W hula 2» 71A [mug a/meaJy [ell/ml a// ,LA Mk M72). W‘e 9'7: Wflomlrmuf ,‘J /l'/Cc/j dag 74> #1 £662) (fie/Z} Page 2 of 8 A C'TS‘C 372 Spring 2009 Term Test :12 ['5] 2. You are interested in investing $100000 in WatReal Inc. which is a real estate company that invests in apartment buildings. WatReal own $100 million in buildings which it has financed with $75 million in mortgages. You. however. feel that this leverage ratio is much too high. You think that the investment would be much better if WatReal had no leverage at all. How might you structure your $100000 investment to undo the effect ofthe leverage? In particular. so that your holdings return the same annual amount as a $100000 equity position in an unlevered version of WatReal. regardless ofwhat the earnings of WatReal actually are. Assume that all investors can borrow or lend at 10%. and ignore taxes and costs associated with financial distress. 7524M; 95% I“ rim-a W 75% m, 541% W O (9/7 (Edzf— 75m ‘/c>7/) 4" 7{/<’/0X 7 0.1%96/I/ UM Laue/J /2(‘/ /ILJ /,_,_________.————« %Au€jvl /w/C n" Iw/L (EM): 0th 575/7. Page 3 of 8 .-l( 7181' 3"] Spring 2009 Term Test ff] r— lJI l__‘ g.) XXX Inc is considering investing in a new project. Assume the follmving. 0 The initial cost of the project is $10 million. and the project is expected to earn $2.5 million EBIT per year for 10 years. which is the life of the project. Assume the project will have no salvage value. 0 XXX stock has a beta of 1.5. The risk free rate is 5% and the market risk premium is 6%. has a current debt to equity ratio of l. The YTM on XXX's debt is 8%. 0 XXX faces a corporate tax rate ol‘ZS‘l'b. Assume no personal taxes. 0 XXX intends to finance the project with the assumption ol‘ $10 million in new debt. which will have an interest rate of 89/0. Assume the principal \\‘ill be paid in l‘ull at the end of the 10 year project. 0 Ignore (CA and costs associated with financial distress. Should XXX invest in the project? Explain. fill”: “/0m + Q.Sm(/"Q52l'677;lro WW5 ,g 57, r 15/52): HZ. F; rDJVTZ(rO’r-‘93[/,7;> 3) r5: //’L/37a \) W73 ? lam '82'957 ' 0/7772 "2 WWW“ 9” WW Q'ldgi’” 7/7 phi/rash Page 4 of 8 ACTSC' 3 73 Spring 2009 Term ’l‘cxl n3 [8] 4. ABC Inc is an all equity firm. Assume the following. - The current expected return on ABC stock is 150/0. 0 The market value ofthe stock is $100 million and 10 million shares are outstanding. 0 A BC wants to change its capital structure by issuing $50 million in debt in order to repurchase shares. 0 ABC laces a corporate tax rate ol"25%. Assume no personal taxes. 0 Assume the EMH holds. {21) Provide the market value balance sheet for ABC immediately bel‘ore the anncmncement ol' the new debt. What is the price per share for ABC's stock? (b) Provide the market value balance sheet for ABC immediately after the announcement. but before the debt issue. What is the new stock price? T5: Saudi: W“ Page 5 of 8 dfl / .»1CTSC' 3 72 (c) (d) Spring 2009 Term Tux! it.” Provide the market value balance sheet after the debt has been issued. What is the new price per share? What is the new rate of return investors will expect from ABC Inc. stock? (a, —pb)(/fr}( fir 71/5” w/f //f7 e/oZM/WIZ/ 3 [a 3 {90m / 50"“ 6261.4 : W Page 6 of 8 :1 (77181 ' 3 72 Spring 2009 Term Test #2 H] 5. (u) Give one example ot‘a direct cost of financial distress. /4(7¢/ fife! 03506. LAM Adm/47,7742} (b) Give one example oi'an indirect cost of financial distress. ._ /451L JéZQJ / tMé/M) 75 W 4410145321 [2] 6. Provide one way a firm can reduce its cost of debt. , Cmu/rJa/r W / 5M1?” WAC/m tar/W741 Page 7 0f 8 ...
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Test_2_Soln - SOLO/76w wfiiéiiibo /_,_,__,,/ University...

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