Shanghai Institute of Foreign Trade
Final examination of corporate finance 2006.6
（Paper A）
Name : ____________________________
Students Number: ___________________________
Marks： __________________________ Exam Rules:
2.5 hours, no formulas, references, or other mechanical devices except non-programmable calculators can be used. Show all your work, all the formulas. Marks will only be assigned for problems for which complete methodology, formulas, and the process is shown. Peeking, copying or duplicating others' work will be considered as \be asked to leave the examination room immediately.
True or false (1 mark each for problems from 1 to 20)
1. In estimating the market value of a bond, the coupon rate should be used as the discount rate. 2. The yield to maturity is equal to the interest payment of a bond..
3. When the interest rate on a bond and its yield to maturity are equal, the bond will trade at par value..
4. Retained earnings represent an internal source of funds that is raised without the payment of
interest, or cost to the firm’s shareholders.
5. If you expect interest rates to go up, you should buy a long-term bond now. 6. Strip bonds are sold at face value.
7. When interest rates rise, bond refunding becomes quite popular.
8. The longer the maturity of a bond, the greater the impact on price to changes in market rates. 9. Valuation of a common stock with no dividend growth potential is treated in the same manner
as preferred stock.
10. Firms with great potential tend to trade at low P/E ratios.
11. The cost of new common stock is greater than the cost of outstanding common stock.. 12. The cost of retained earnings is equal to the required rate of return on a firm's common stock..
13. The calculation of the cost of capital depends upon historical costs of funds. 14. Generally, the higher the coefficient of variation a project has, the higher the discount
rate it should be assigned. 15. Projects that are totally uncorrelated provide some overall reduction in portfolio risk. 16. A common stock with a beta of 1.0 is said to be of equal risk with the market. 17. Risk is not only measured in terms of losses, but also in terms of variability.
18. The efficient market hypothesis is generally concern with the impact of information on the
behavior of stock prices.
19. A stock split involves a reduction in the firm's retained earnings account .
20. Investors in high marginal tax brackets prefer dividends while investors in low marginal tax brackets prefer to have corporate earnings reinvested.
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Choice (1 mark each for problems from 21 to 40)
21. A ten year bond pays 8% annual interest ( paid semi-annually ). If similar bonds are currently yielding 6% annually, what is the market value of the bond ?
A. $1,000.00 B. $1148.77 C. $1155.77 D. none of the above 22. The relationship between a bond's price and the yield to maturity
A. changes at a constant level for each percentage change of yield to maturity. B. is an inverse relationship C. is an linear relationship D. a and b .
23. For a firm paying 7% for new debt, the higher the firm's tax rate
A. the higher the aftertax cost of debt. B. the lower the aftertax cost of debt. C. aftertax cost is unchanged.
D. not enough information to judge.
24. Using the constant dividend growth model for common stock, if P0 goes up
A. the assumed cost goes up.
B. the assumed cost goes down.
C. the assumed cost remains unchanged.. D. need further information.
25. A firm is paying an annual dividend of $3.63 for its preferred stock which is selling for $62.70. There is a selling cost of $3.50. What is the aftertax cost of preferred stock if the firm's tax rate is 33% ?
A. 2.02% B. 4.09% C. 5.79% D. 6.11%
26. The coupon rate on an issue of debt is 12%. The yield to maturity on this issue is 14%. The corporate tax rate is 31%. What would be the approximate aftertax cost of debt for a new issue of bonds?
A. 4.34% B. 3.72% C. 9.66% D. 8.28%
27. A firm's stock is selling for $78. The next annual dividend is expected to be $2.70. The growth rate is 9%. The flotation cost is $5.00. What is the cost of retained earnings? A. 13.09% B. 12.46% C. 12.75% D. none of the above 28. The aftertax cost of debt will always below
A. the before-tax cost of debt.
B. the weighted average cost of capital. C. the cost of equity.
D. all the above.
29. An investment project has a positive net present value. The internal rate of return is
A. less than the cost of capital B. greater than the cost of capital C. equal to the cost of capital
D. indeterminate, it depends on the length of the project 30. Cash flow can be said to equal
A. income before amortization and taxes minus taxes. B. income before amortization and taxes plus taxes.
C. income before amortization and taxes plus amortization.
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D. income aftertax minus amortization . 31. As the cost of capital increases
A. fewer projects are accepted. B. more projects are accepted.
C. project selection remains unchanged.
D. none of the above.
32. The payback method has several disadvantages, among them:
A. payback fails to choose the optimum or most economic solution to a capital budgeting problem.
B. payback ignores cash inflows after the payback period. C. a and b .
D. none of the above.
33. The \
A. alternatives with neutral combinations of risk and return.
B. alternatives with the highest returns.
C. alternatives with the best combinations of risk and return. D. alternatives with no risk .
34. The coefficient of variation ( V ) can be defined as the
A. expected value multiplied by the standard deviation.
B. standard deviation divided by the mean (expected value). C. mean (expected value ) divided by the standard deviation. D. standard deviation squared, divided by the expected value. 35. Which investment has the least of risk ?
A. Standard deviation = $500, Expected return = $ 5,000 B. Standard deviation = $700, Expected return = $ 500
C. Standard deviation = $900, Expected return = $ 800 D. Standard deviation = $400, Expected return = $ 300
36. Which of the following is not a criteria for an efficient market ?
A. prices adjust rapidly to new information.
B. large dollar amounts of securities can be absorbed without price destabilization.C. each successive trade is made at a price close to the previous trade. D. computerized handling of transactions.
37. The efficient market hypothesis has several forms. The weak form states that
A. past price date is unrelated to future prices.
B. prices reflected all public information.
C. all information both public and private is immediately reflected in share prices. D. none of the above
38. In an efficient market
A. All financial transactions have an NPV equal to zero.
B. The investor does not receive abnormal returns consistently. C. The investor is compensated properly for risk borne.
D. All the above are correct.
39. A firm with excess cash and few investment alternatives might logically
A. declare a stock dividend.
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B. split its stock two-for-one.
C. repurchase some of its own shares. D. choose to issue preferred stock. 40. A stock dividend will
A. increase the value of a share of stock.
B. decrease the common stock account. C. decrease the retained earnings account. D. none of the above. Problems
41. Diaz Camera Company is considering two investments, both of which cost $10,000. The cash flows are as follows:
Year Project A Project B? 1 $6,000 $5,000 2 4,000 3,000 3 3,000 8,000
a. Which of the two projects should be chosen based on the payback period? (4 marks ) b. Which of the two projects should be chosen based on the net present value method?
Assume a cost of capital of 10 percent (4 marks )
42. Simon calls his broker to inquiry about purchasing a bond of Disk Storage System. His
broker quotes a price of $1,180. Simon is concern that the bond might be overpriced based on the facts involved. The $1,000 par valve bond pays 14 percent annual interest payable
semiannually, and it has 25 years remaining until maturity. The current yield to maturity on similar bonds is 12 percent. Compute the new price of the bond and comment on whether you think it is overpriced in the marketplace? ( 6 marks )
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43. Given the follow information, calculate the weighted average cost of capital for Glamour Girl Cosmetics. Line up the calculations ( Kd , Kp ,Ke WACC ) in the order shown in the following . ( 10 marks ) Percent of capital structure:
Debt 40% Preferred stock 10% Common equity 50%
Additional information
Bond coupon rate 12% Bond yield 10% Dividend, expected common $3.00 Dividend, preferred $9.20 Price, common $60.00 Price, preferred $99.00 Flotation cost, preferred $4.00 Corporate growth rate 9% Corporate tax rate 30%
44. Skyline Corp. will invest $130,000 in a project that will not begin to produce returns until
after the third year. From the end of the 3rd year until the end of the 12th year (10 periods), the annual cash flow will be $34,000. If the cost of capital is 12 percent, should this project be undertaken ? (6 marks)
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45. The Taylor Corporation is using a machine purchased two years before. The machine has a
book value of 66,000 and a current market value of $40,000. The asset is in the Class 8 CCA pool (20 percent CCA rate). It will have no salvage value after 5 years and the tax rate is 40 percent. Jacqueline Elliot, the chief Financial Officer of Taylor is considering replacing this machine with a new model that costs $70,000. The new machine will cut operating costs by $10,000 per year for 5 years. Taylor’s cost of capital is 8 percent. Should the firm replace the asset? (Use the NPV methodology to solve this problem) ( 8 marks )
46. The Presley Corporation is about to go public. It currently has a aftertax earnings of $7.5
million, and 2.5 million shares are owned by the present stockholders (the Presley family).
The new public issue will represent 600,000 new shares. The new shares will be priced the public at $20.00 per share, with a 5 percent spread on the offering price. There will also be $200,000 in out-of-pocket costs to the corporation.
a. Compute the net proceeds to the Presley Corporation. (3 marks )
b. Compute the earnings per share immediately before the stock issue. (3 marks ) c. Compute the earnings per share immediately after the stock issue. (3 marks)
d. Determine what rate of rate of return must be earned on the net proceeds to the corporation so that there will not be a dilution in earnings per share during the year of going public. (4 marks) e. Determine what rate of rate of return must be earned on the net proceeds to the corporation so that there will be a 5 percent increase in earnings per share during the year of going public. (4 marks)
47. The shares of Dyer Drilling Co. sell for $60. The firm has a P/E ratio 15 and 40 percent of
earnings are paid out in dividends. What is the dividend yield? (5 marks)
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