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Unformatted text preview: FIN 4414 – Second Midterm Exam  Code C  Solutions Page 1 Name (Printed) ______________________________________ Section ___________ FIN 4414 Financial Management Sections 2109 and 2111 Second Midterm Exam – Code C – Solutions April 13, 2011 Note: This midterm exam consists of 3 short essays, worth 10 points each, and 14 problemoriented questions, worth 5 points each. By turning in this exam I am confirming that all work on this exam is my own and that I have not received help from other individuals in answering the specific questions on this exam. Student’s Signature __________________________________________________________ FIN 4414 – Second Midterm Exam  Code C  Solutions Page 2 Score _______________ 1. In the space provided below, summarize (1) what Brooksley Born, in the Frontline video, The Warning , was concerned about, (2) what she tried to do about it, (3) who she fought and whether she was successful, (4) what subsequently happened to prove her correct or incorrect, and (5) your views on this matter. Various Responses Are Acceptable 2. In the space provided below, discuss (2) what we mean by usury, and (2) how Russell Sage (the Sage Foundation), was able to use putcallparity to circumvent the usury laws of the State of New York  be specific. Various Responses Are Acceptable 3. There is no correct answer for this question, but completion of this question is worth 10 points: In the space provided below, discuss what you now know (have learned) about three (3) specific topics that you did not know at the beginning of the term, or skills that you have developed. If you have not learned anything new, discuss what topics/skills you believe should have been covered. Various Responses ProblemOriented Questions, Worth 5 Points Each 4. Assume that a firm’s current capital structure consists of 50 percent debt and 50 percent common stock (a debt/equity ratio of 1/1 or 1.00). Assume that the firm’s beforetax cost of debt is 7 percent, that its tax rate is 40 percent, and that its cost of common stock is 16 percent. Also assume that the riskfree rate is 3 percent and that the market risk premium is 10 percent; you should now be able to calculate the firm’s current WACC and its current levered beta. Now assume that the firm plans to change to a capital structure of 80 percent debt and 20 percent equity (a debt/equity ratio of 0.80/0.20 or 4.0), and that this increase in leverage will increase its beforetax cost of debt to 10 percent. Given this information, determine what the difference will be between the firm’s current WACC and the firm’s new WACC. A. 0.585% * B. 0.825% C. 1.065% D. 1.305% E. 1.545% Current WACC = (0.07)*(1  0.40)*(0.50) + (0.16)*(0.50) = 10.10% Determine current levered beta: FIN 4414 – Second Midterm Exam  Code C  Solutions Page 3 16.0% = 3.0% + (10.0%)*( β L ) β L = (16.0%  3.0%) / 10.0% = 1.30 Unlever beta: β U = (1.30) / (1 + (1.00)(1.40)) = 0.8125 Relever beta at new capital structure:...
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