Study Guide for Final Exam 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. (Points: 20) 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) 3. (TCO E) Dakota Trucking Company (DTC) is evaluating a potential lease for a truck with a 4-year life that costs $40,000 and falls into the MACRS 3-year class. If the firm borrows and buys the truck, the loan rate would be 10%, and the loan would be amortized over the truck’s 4-year life. The loan payments would be made at the end of each year. The truck will be used for 4 years, at the end of which time it will be sold at an estimated residual value of $10,000.
If DTC buys the truck, its after tax cash flows would be the following: (Year 1) – 6,339; (Year 2) -4,764; (Year 3)-9,943; (Year 4) -5,640; all occurring at the end of respective years. The lease terms, call for a $10,000 lease payment (4 payments total) at the beginning of each year. DTC’s tax rate is 40%. Should the firm lease or buy? (a) $849 (b) $896 (c) $945 (d) $997 (e) $1,047 (Points: 20) 4. (TCO I) Suppose 90-day investments in Britain have a 6% annualized return and a 1. 5% quarterly (90-day) return. In the U. S. 90-day investments of similar risk have a 4% annualized return and a 1% quarterly (90-day) return. In the 90-day forward market, 1 British pound equals $1. 65. If interest rate parity holds, what is the spot exchange rate? (a) 1 pound = $1. 8000 (b) 1 pound = $1. 6582 (c) 1 pound = $1. 0000 (d) 1 pound = $0. 8500 (e) 1 pound = $0. 6031 (Points: 20) 1. (TCO C) D. Paul Inc. forecasts a capital budget of $725,000. The CFO wants to maintain a target capital structure of 45% debt and 55% equity, and it also wants to pay dividends of $500,000.
If the company follows the residual dividend policy, how much income must it earn, and what will its dividend payout ratio be? Net Income Payout (a) $898,750 55. 63% (b) $943,688 58. 41% (c) $990,872 61. 43% (d) $1,040,415 64. 40% (e) $1,092,436 67. 62% (Points: 20) 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
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)