Buster’s Beverages is negotiating a lease on a new piece of equipment that would cost $100,000 if purchased. The equipment falls into the MACRS 3-year class, and it would be used for 3 years and then sold, because the firm plans to move to a new facility at that time.

FIN 516 Week 8 Final Exam Guide

Question 1.1. (TCO B) Which of the following statements concerning the MM extension with growth is not correct?
(a) The tax shields should be discounted at the unlevered cost of equity.
(b) The value of a growing tax shield is greater than the value of a constant tax shield.
(c) For a given D/S, the levered cost of equity is greater than the levered cost of equity under MM’s original (with tax) assumptions.
(d) For a given D/S, the WACC is greater than the WACC under MM’s original (with tax) assumptions.
(e) The total value of the firm is independent of the amount of debt it uses.

Question 2.2. (TCO D) Which of the following statements is most correct?
(a) In a private placement, securities are sold to private (individual) investors rather than to institutions.
(b) Private placements occur most frequently with stocks, but bonds can also be sold in a private placement.
(c) Private placements are convenient for issuers, but the convenience is offset by higher flotation costs.
(d) The SEC requires that all private placements be handled by a registered investment banker.
(e) Private placements can generally bring in funds faster than is the case with public offerings. (Points : 20)

Question 3.3. (TCO E) Buster’s Beverages is negotiating a lease on a new piece of equipment that would cost $100,000 if purchased. The equipment falls into the MACRS 3-year class, and it would be used for 3 years and then sold, because the firm plans to move to a new facility at that time. The estimated value of the equipment after 3 years is $30,000. If the borrow and purchase option is used, the cash flows would be the following: (Year 1) -2,400; (Year 2) -3,800; (Year 3) -1,400; (Year 4) -79,600; all of these cash outflows would be at the beginning of the respective years. Alternatively, the firm could lease the equipment for 3 years, with annual lease payments of $29,000 per year, payable at the beginning of each year. The firm is in the 20% tax bracket. If it borrows and purchases, it could obtain a 3-year simple interest loan, to purchase the equipment at a before-tax interest rate of 10%. If there is a positive net advantage to leasing, the firm will lease the equipment. Otherwise, it will buy it. What is the NAL?
(a) $5,736
(b) $6,023
(c) $6,324
(d) $6,640
(e) $6,972 (Points : 20)

Question 4.4. (TCO I) Suppose hockey skates sell in Canada for 105 Canadian dollars, and 1 Canadian dollar equals 0.71 U.S. dollars. If purchasing power parity (PPP) holds, what is the price of hockey skates in the United States?
(a) $14.79
(b) $63.00
(c) $74.55
(d) $85.88
(e) $147.88 (Points : 20)

Page 2

Question 1.1. (TCO C) Dentaltech Inc. projects the following data for the coming year. If the firm follows the residual dividend policy and also maintains its target capital structure, what will its payout ratio be?

EBIT $2,000,000
Capital budget $850,000
Interest rate 10%
% Debt 40%
Debt outstanding $5,000,000
% Equity 60%
Shares outstanding $5,000,000
Tax rate 40%

(a) 37.2%
(b) 39.1%
(c) 41.2%
(d) 43.3%
(e) 45.5% (Points : 20)

Question 2.2. (TCO F) Warren Corporation’s stock sells for $42 per share. The company wants to sell some 20-year, annual interest, $1,000 par value bonds. Each bond would have 75 warrants attached to it, each exercisable into one share of stock at an exercise price of $47. The firm’s straight bonds yield 10%. Each warrant is expected to have a market value of $2.00 given that the stock sells for $42. What coupon interest rate must the company set on the bonds in order to sell the bonds-with-warrants at par?
(a) 7.83%
(b) 8.24%
(c) 8.65%
(d) 9.08%
(e) 9.54% (Points : 20)

Question 3.3. (TCO B) Reynolds Resorts is currently 100% equity financed. The CFO is considering a recapitalization plan under which the firm would issue long-term debt with a yield of 9% and use the proceeds to repurchase common stock. The recapitalization would not change the company’s total assets, nor would it affect the firm’s basic earning power, which is currently 15%. The CFO believes that this recapitalization would reduce the WACC and increase stock price. Which of the following would also be likely to occur if the company goes ahead with the recapitalization plan?

(a) The company’s net income would increase.
(b) The company’s earnings per share would decline.
(c) The company’s cost of equity would increase.
(d) The company’s ROA would increase.
(e) The company’s ROE would decline. (Points : 20)

Question 4.4. (TCO G) Which of the following statements is most correct?
(a) Our bankruptcy laws were enacted in the 1800s, revised in the 1930s, and have remained unaltered since that time.
(b) Federal bankruptcy law deals only with corporate bankruptcies. Municipal and personal bankruptcy are governed solely by state laws.
(c) All bankruptcy petitions are filed by creditors seeking to protect their claims against firms in financial distress. Thus, all bankruptcy petitions are involuntary as viewed from the perspective of the firm’s management.
(d) Chapters 11 and 7 are the most important bankruptcy chapters for financial management purposes. If a reorganization plan cannot be worked out under Chapter 11, then the company will be liquidated as prescribed in Chapter 7 of the Act.
(e) Restructuring a firm’s debt can involve forgiving a certain portion of the debt, but it cannot call for changing the debt’s maturity or its contractual interest rate. (Points : 20)

Page 3

Question 1.1. (TCO I) In 1985, a given Japanese imported automobile sold for 1,476,000 yen, or $8,200. If the car still sold for the same amount of yen today but the current exchange rate is 144 yen per dollar, what would the car be selling for today in U.S. dollars?
(a) $5.964
(b) $8,200
(c) $10,250
(d) $12,628
(e) $13,525 (Points : 20)

Question 2.2. (TCO H) Which of the following statements is most correct?
(a) The acquiring firm’s required rate of return in most horizontal mergers will not be affected, because the two firms will have similar betas.
(b) Financial theory says that the choice of how to pay for a merger is really irrelevant because although it may affect the firm’s capital structure, it will not affect its overall required rate of return.
(c) The basic rationale for any financial merger is synergy, and thus, the estimation of pro-forma cash flows is the single most important part of the analysis.
(d) In most mergers, the benefits of synergy and the premium the acquirer pays over the market price are summed and then divided equally between the shareholders of the acquiring and target firms.
(e) The primary rationale for most operating mergers is synergy. (Points : 20)

Question 3.3. (TCO A) An investor who writes standard call options against stock held in his or her portfolio is said to be selling what type of options?
(a) In-the-money
(b) Put
(c) Naked
(d) Covered
(e) Out-of-the-money (Points : 20)

Question 4.4. (TCO F) A swap is a method used to reduce financial risk. Which of the following statements about swaps, if any, is not correct?
(a) A swap involves the exchange of cash payment obligations.
(b) The earliest swaps were currency swaps in which companies traded debt denominated in different currencies, say dollars and pounds.
(c) Swaps are very often arranged by a financial intermediary, who may or may not take the position of one of the counterparties.
(d) A problem with swaps is that no standardized contracts exist, which has prevented the development of a secondary market.
(e) A company can swap fixed interest payments for floating interest payments. (Points : 20)

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