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Name __________________________________ Webct User Name __________________________________ University of Houston C. T. Bauer College of Business Finance 3332 Principles of Financial Management Fall, 2008 Exam 3B To receive full credit, show all work—equations in variable form, equations with numbers plugged in—and clearly indicate your answer. All inputs must be shown when using financial functions. Woolford Corporation, whose stock is selling for $50 per share, has the following stockholder equity account. Common Stock ($2.00 par, 500,000 shares) $ 1,000,000 Additional Paid in Capital 6,000,000 Retained Earnings 9,000,000 Total Stockholders Equity $16,000,000 1. i) The firm declared a 5 for 1 stock split. Show the effect of the stock split on the stockholders equity account. (Fill in the blanks.) (6) Common Stock ($___ par, ____________ shares) $ __________ Additional Paid in Capital __________ Retained Earnings __________ Total Stockholders Equity $ __________ ii) What effect will the stock split have on stockholder wealth? (2) iii) What effect may cause the stock price to increase in response to the announcement of the stock split? (2)
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Use the following information for questions 2 and 3. Sydney Industries is planning an expansion costing $600,000. It can finance with new equity sold to net $30 per share, or with the sale of bonds with an 8% coupon. The firm’s marginal tax rate is 40%. Sydney currently has the following simplified balance sheet. Liabilities and Capital Common Stock at $1 par 500,000 shares outstanding 500,000 Additional Paid in Capital 800,000 Retained Earnings 1,000,000 Total Liabilities and Capital $2,300,000 2. What is the EBIT-EPS indifference point of the two financing plans? (8) 3. After the expansion from the above problem, the firm’s EBIT is expected to be $2,000,000 with a standard deviation of $561,100. What is the probability that earnings per share under the debt plan will exceed earnings per share under the equity plan? (6) Unleveraged Firm Leveraged Firm Cost of equity k e 8% 8.272727% Debt in capital structure -- $600,000 Pretax cost of debt k d -- 6% Net operating income (EBIT) $400,000 $400,000 4. What is the value of the tax shield to the Leveraged firm, assuming perfect capital markets with corporate taxes at 40%? (8) 5. Determine the market value of the Leveraged firm using the discounted cash flow method, assuming perfect capital markets with corporate taxes at 40%. (4) 2
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6. Management is planning for a capital budget of $100 million. Retained earnings for the
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